The dark side about investing and blogging
(just like Star Wars Skywalker vs Palpatine- there will always be light and
dark in the Force) is that there are some sinister folks lurking in some dark corner condemning your every investment action and then gloating if one’s
investments started making losses albeit the fact that there are very few
investors who strike gold with every investment decisions that they made
without a single failure.
The topic that I am going to touch on today is
on under-highlighted points to take note of using leverage through margin
financing facility provided by the stockbroking firms. It has been a good start
for FY2020 with the brokerage firm that I am using for credit facility- Maybank
Kim Eng- offering a cut of 0.2% interest expense to bring down the effective
annual financing charge to 3.3% from 3.5% previously for its grade based
financing option, based on the financial resilience of the underlying
securities. The other option is a fixed interest rate for all types of
securities financing under an approved listing and it is currently at 5.8% for
equities and 2.8% for bonds.
Naturally, when I embarked on taking out a
margin facility, my relatives, colleagues and friends all rushed in (most with well-meaning
intentions but a few making condescending remarks) to share with me horror stories they heard and “personal account”
of what went wrong. Basically, the “asserted common truth” is that those who
dabbled in margin financing eventually gets into financial ruin and bankruptcy.
Margin account is an evil sin akin to habitual gambling and that the general consensus
from these folks is that I am silly to have opened a margin
facility for my investments and that I should get out while I can, before the
stock market collapse that they claimed is inevitably imminent.
Peril
1: A sword is always a double-edged weapon
I will not want to go too detailed into the point on the magnification of losses and gains from margin account as it has
already been covered many times on investment forums and blogs. To me, my main
investment objective is not dominated by a capital growth strategy. I am more
of an income driven investor. The main point here is that one will need to
prepare for a 50% to 60% plunge in value of one’s portfolio and to survive the
margin call during period of severe economic crisis. If one got into forced
liquidation by the broker, then all is lost as selling at the trough of a
crisis will cause irreparable harm to one’s asset portfolio.
You folks would have noticed from my
investment portfolio that I have 2 emergency buffers here, namely, (i) fully paid equities
that can be transferred immediately into the margin account to top up the
collateral as well as (ii) maintaining a higher hard cash on hand for
deployment. The essence here is not to max out your margin account but to be
very conservative on its use which will thus enhance the effect of leverage on
production of recurring income. Also, minimising the volatility of your income
producing portfolio during construction is another vital point.
Saying that, a few nightmare scenarios can
still happen-Murphy’s Law. For example:
(i)
You are on
an overseas work or holiday trip and did not immediately realise that the stock
market has dropped and your margin account fall below 140% ratio and by the
time you realised, forced liquidation already commenced.
(ii)
While
overseas, you tried using the security token to transfer the cash from your
bank to top up your margin account but the token has broken down. By the time
you got a replacement security token, your cash top up is already late and you
are forced to liquidate.
Peril
2: Brokerage firm can increase the
interest rate by serving short notice
Margin account is subject to interest rate
fluctuation risk here. No stock brokerage firm will dare offer anyone a fixed
interest rate perpetually based on the date of taking up the account opening offer.
In the event that global interest rates start climbing again, you will be
looking at servicing a higher interest cost which can substantially reduce your
dividends or interest income.
Also, if say a fire happens to burn down
Paragon shopping centre (the jewel of SPH REIT) in Orchard, the broker can just
downgrade SPH REIT to a higher risk counter with a lower score and grading
which will almost double the financing cost overnight.
Peril
3: Brokerage firm can just decide to stop future financing of a counter
Brokerage firms provide credit based on an
approved listing by their internal risk management team. A counter that appears
today may no longer be approved tomorrow.
Let’s take the extreme fictitious scenario
using Eagle Hospitality Trust. Assume that in future, it really turns out that
the sponsor has going concern issue and Queen Mary lease was deemed a default,
the brokerage firm can just simply call it quit to minimise credit default
risk. Brokerage firms generally have the rights to serve their clients notice
that financing will cease immediately and request for top up after a designated
notice period. One will be forced to liquidate one’s position and given no
chance to await recovery of the price of the counter.
Peril
4: Transactions such as dividend processing, corporate actions maybe chargeable
A typical dividend transactional fees is min
S$5 or 1% of the dividends being processed whichever is higher. So say if you
are holding on to SPH REIT, you will have to pay at least S$20 since it
declares dividends quarterly. If you hold 10 REITs with quarterly dividend,
that will be S$200 annually in dividend processing fees.
Other recurring fees include CDP sub-account
fees and custodian fees.
Non-recurring fees will be those relating to
corporate accounts such as rights issue.
However, the good news here is that generally,
if you are taking out a significant margin facility with your brokerage firm,
most of the charges can be negotiated to be absorbed by their company. But if
you only want to borrow S$2K or S$3k to buy stocks using margin account, then
it may not be worth it after accounting for transactional cost.
Parting
Thoughts
If you intend to use margin account, do take
note of its potential perils. I think that an even more important point is to
ensure that the trading representative handling your account knows the basic
technical specialties regarding trading via margin account so as to advise you
correctly. I have come across trade representative who do not know how interest
expense is calculated if one buys stocks on margin account.
One good example as follow:
If you deposit cash of S$20K to start the
margin account (@3.3% per annum rate) and bought S$10K worth of stocks at the beginning
of the month, what will be the interest expense chargeable at month end? You
will be surprised that there are trading representatives who can’t answer this
straight away and need to check internally. Another one told me proudly that
since the interest is S$330 per annum, the interest chargeable per month will
be S$27.50 (S$330 divide by 12mths) and my eyes nearly popped out of my head.
So far so good with Maybank Kim Eng. They have
a well-trained and dedicated team of CSO and trading representatives who make
good use of technology such as mobile phone wat’s App to communicate with
clients. Their new trading platform is simply fabulous. It is customisable with
many viewing panes depending on your own unique preferences. The other
brokerage such as Phillip Securities and UOB Kay Hian are offering cheaper
margin financing rates than Maybank Kim Eng but unfortunately, only for a
limited period as part of their promotion and with no guarantee rates will hold
upon expiry.
Please see my previous posting on margin
account opening:
