Gearing into ETF’s and the Core-Satellite model

Gearing into ETF’s and the Core-Satellite model

Exchange Traded Funds (ETFs) have fast become a go to for investors seeking diversification and low cost passive investment.

ETFs can be a cost-effective way to access different sector or market indices and strategies. They are also a straightforward way for an investor to obtain additional or specific exposure without having to hold individual stocks, which may be more difficult to manage. For example, this can be the case when holding international securities directly or multiple securities across different global exchanges, as there are different time zones and currencies which add complexity.

Another advantage is that if the ETF is issued in Australia, the provider will usually supply information regarding tax reporting and dividends (if applicable) in Australian dollars, making reporting of ETF income simpler in tax returns.

Diversified Exposure

ETFs may also offer diversified exposure, this may include a fund of funds that consists of a basket of underlying ETFs covering a broad range of market sectors, geographies and both growth and defensive asset classes. These funds have a pre-determined strategic asset allocation to cater for a range of risk profiles i.e. the product range of diversified ETFs cater for conservative through to high growth risk profiles. Diversification is a proven strategy to mitigate volatility.

Core-Satellite model

A strategy used by many investors is the ‘Core-Satellite’ approach, where the core of a portfolio might be made up of several large cap index ETFs, for example S&P500 and ASX200. By holding the main indexes as a core, they ensure their return is relatively consistent with the overall market.

They can then look at ‘thematic’ ETFs making up smaller amounts of the portfolio. The investor might favour these sectors and use them to generate extra return if they believe those are growth areas but not want oversized exposure.

Examples could include thematic ETFs that concentrate on renewable energy, semiconductors, cybersecurity or AI just to name a few.

A typical allocation using this approach might be 80% core and 20% satellites.
Of course, there are no guarantees the satellites will beat the core index based investments and continually trading the satellites could generate extra brokerage costs as well.

Get exposure to global growth.

Australian investors can use international ETFs to gain access to international equities, both US and non-US, to get exposure to global growth. This allows a portfolio to obtain some international exposure relatively quickly and easily with the security able to be traded on the ASX.

Examples of international ETF’s tracking indexes are ETFs for the S&P500 index, Nasdaq 100 index, or non-US indexes such as the FTSE 100. However, investors should consider that the underlying holdings domiciled in a foreign country may have currency risk, unless this is hedged by the provider.

Gearing into ETFs

Leveraged offers a broad range of ETFs that can be used in a margin loan, which cover various indexes both domestic and internationally, and specific sectors that may complement an investor’s portfolio and be used in a core-satellite model.

Combine the benefits of gearing:

• Ability to negatively gear your investments.
• Bring forward a tax deduction by fixing and pre-paying at EOFY.
• Increase your exposure to equities using borrowed funds.
• Diversify your existing portfolio without the need to re-allocate existing assets and trigger capital gains tax.

With the benefits of holding ETFs:

• Diversification.
• Easy access to international markets.
• Easy access to themes or market sectors.
• Powerful tool for portfolio construction: Core and Satellite approach or pick a single diversified ETF based on your risk profile.
• Easy tax reporting for distributions. One single AMMA statement instead of. multiple dividend statements.

Risks

Investing into equity markets and other investments is not without risk. By using a margin loan and gearing strategy, your losses can be magnified as you are exposed to a larger position in the market than you otherwise would be without gearing. It is possible for certain events (such as margin calls) to occur at any time that may result in some (or all) of the loan being due for payment immediately, depending on the nature of the event. Other risks include interest rate changes and legislative risk.

As with all market based investments, there are risks to consider. When considering gearing into ETFs, your investment may not perform as expected, leading to potential capital losses. The ETF may not perform in line with your expectations or deliver a negative return. As ETFs are also offered by an external manager there is also the reliance on that managers expertise and ability to be able to manage your investment and manage their operational risk. Fees charged may also reduce your overall performance.

Conclusion

Combining both products could create a tax effective^* way to grow your wealth long term.

As ETFs are added to the ASX Leveraged is adding new ETFs all the time. Check out our Acceptable Investment List to see what we can offer for your portfolio.

If you are considering how you may be able to fulfil your investment goals using a gearing strategy, a Leveraged margin loan might be able to help you. If you would like to find out more about a margin loan or products offered by Leveraged Equities, please contact us on 1300 307 807.

If you are financial adviser and want to learn more about recommending gearing and using ETFs to your clients, contact one of our Business Development Managers today.