Tread warily with geared share funds

They have outpaced the sharemarket in the past four years, but geared funds typically plummet when the market slides. By MICHAEL LAURENCE.

By Michael Laurence

More than 30 Australian share funds have left the general sharemarket in their dust over recent years, some producing breathtaking annual returns of more than 50%. These so-called geared funds, with internal borrowings averaging half of their value, typically go like a rocket when markets are rising yet their returns typically plummet when markets are sliding.

Take the wholesale version of the Colonial First State Geared fund (Colonial was the pioneer of these innovative products). As shown in the accompanying table from Morningstar Research, this fund delivered an annualised return of 50.36% in the three years to February 28, against a 25.4% annualised return from the S&P/ASX 300 Accumulation Index.

But go back to 2002 – a much tougher time for investors – and the only two geared funds then on the market (both Colonial First State products) had negative returns of more than 30% for the single calendar year.

In a way, geared share funds illustrate the position of the overall sharemarket at this time, only magnified many times over. Their returns are expected to become increasingly volatile after exactly four years of sharply rising share prices.

David Rolleston, a director of UBS Wealth Management Australia, says a key for anyone considering a geared share fund is to really understand the products. “I think they can be very appropriate where gearing is appropriate for an investor’s risk profile.”

Here are 10 straightforward questions to provide an insight into the advantages and disadvantages of these funds:

1: How do the funds operate?

The funds borrow internally to help finance their investments. The funds typically borrow half of the value of their investment portfolios.

2: What is the advantage of a fund having internal gearing?

Individual investors don’t have to borrow to buy to invest and, typically, the investment fund manager has access to money at lower interest rates than you can obtain, says financial planner Robert Lipman, chief executive of Investec Private Advisers. For example, the Commonwealth Bank owns Colonial First State and should be a great source of cheap money for its own funds management group.

You will not face any margin calls, a distinct possibility if you were to personally borrow to buy shares; or, alternatively, you would not have to take out an investment loan with your home, for instance, as security for an investment loan.

The most you can lose with these investments is your initial capital outlay. This may provide some degree of comfort.

3: How volatile are these funds?

Their volatility is generally twice that of the sharemarket – differing of course, depending upon their extent of borrowing. This means that if the market were to rise by, say, 10%, the value of your units is likely to rise by 20%. But if the market were to turn down, the opposite exaggerated movement would occur.

4: Are these funds appropriate for investors seeking income?

No. Geared funds typically distribute little income and are designed for investors seeking long-term capital gains. Their investments, of course, produce large, highly valuable imputation credits from their Australian portfolios.

5: Are these long-term investments?

Unquestionably. “One of the downsides of these funds,” says Lipman, “is that your volatility is twice that of the general market. You should therefore accept that your money should be invested for the long term.” He generally suggests an investment time-frame of six or seven years.

6: Given the share rises in the market, is this a smart time to enter these funds?

Lipman is not necessarily against investors entering geared share funds at this time; despite the rises in share prices (making them “fully priced”, in broker parlance) and expectations that volatility may increase. But he reiterates that investors should be prepared to remain invested for the long term. The suitability of these products depends on the personal circumstances of individual investors, including their tolerance to volatility.

However, Lipman advises investors who are thinking about using geared share trusts for the first time to be cautious in their approach. Perhaps invest your capital sum progressively in two or three lots, rather than all at once, and ensure the funds represent a “very small component” of an overall investment portfolio that is adequately diversified between the main investment sectors of shares, property, bonds and cash.

These funds should not make up a dominating part of your portfolio, according to Lipman. And David Rolleston of UBS Wealth Management echoes Lipman’s views about the desirability for an adequately diversified portfolio with geared share funds making up a very small proportion, if any, of such a portfolio.

Rolleston comments: “I would be more cautious about using these products today than 12 months ago given that the market is not seen as being undervalued.”

7: If I have already made a decent profit from geared funds, should I be selling now?

Lipman’s general view is that investors should not try to time markets and trigger unnecessary capital gains by selling whenever the market may seem at a high.

8: Do some of the fund managers have different styles?

Yes. Colonial First State, for instance, has a growth investment style, meaning the portfolio managers select shares for the expected growth in company earnings; while 452 Capital, for example, is a value investor, meaning the manager aims buy stocks that are considered undervalued. (As a rule, growth managers outperform value managers in rising markets.) And some managers, such as ING, use a multi-manager approach for its geared share fund.

Perhaps ironically, 452 Capital products are only available through Colonial First State.

Lipman says that given the sharp rise in the market, investors may be “marginally better” to use a manager with a value rather than a growth style at this time.

9: Are geared equity funds acceptable investments for diy super funds?

Lipman says the answer is generally yes – based on the caveats given above. A self-managed super fund is not permitted to borrow to investment, apart from in highly limited circumstances.

But the internal borrowing within the fund provides a de facto and legal means for a self-managed super fund to gain the benefits of borrowing without borrowing. And super funds, particularly in their wealth-creation phases, typically want to maximise capital gains while minimising income – a characteristic that neatly matches the profile of geared share funds.

10: Can investors negatively gear their investments into geared funds?

Yes. But you will be really magnifying the impact of any movements in the market. This would be a brave strategy at this time.

Explosive performers


6mth (%)

1yr (%)

3yr (%)

Advance Aust. Geared




AMP Capital Geared




BT Geared Imputation




Colonial First State Geared




Colonial First State Geared (wholesale*)




Fiducian – Geared Aust. (retail)




452 Capital




Perpetual Wealth Focus Geared




Skandia GIS Blended Geared




Source: Morningstar Research

Footnotes Returns to February 28:

* The above returns are retail products except the second Colonial First State fund which is listed because of its mention in the article. Wholesale products are often available from the same fund managers and produce higher returns to reflect their lower fees. These is only a sample of the available geared funds.



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