Original Article on Economic Times
5 Sep, 2007, 1020 hrs IST,Shailesh Menon, TNN
MUMBAI: Shashank Batra (name changed), a Mumbai-based businessman, has been investing in mutual funds for the past eight years, and now has a mutual fund portfolio of about Rs 1 crore. Apart from this, Mr Batra also likes to dabble in stocks whenever he gets some “hot tips” from his broker. Of late, he has been reluctant to put fresh money into stocks. That is when a relationship manager at a brokerage house introduced him to the concept of borrowing funds through ‘portfolio leveraging’. The idea appealed to Mr Batra, who gave his go-ahead to the relationship manager to arrange for funds by pledging his mutual fund portfolio.
Mr Batra is not an isolated instance. An increasing number of high net worth individuals (HNIs), who have sizeable holdings in mutual funds, are said to be borrowing money through portfolio leveraging. Under portfolio leveraging, the investor pledges his mutual fund portfolio (or share portfolio) to raise a loan.
Suppose, the investor has a mutual fund portfolio worth Rs 30 lakh, he’ll pledge the whole lot with an investment company, mostly non-banking financial companies (NBFCs), to take a loan. Most firms give 60-70% exposure on the portfolio pledged.
Assuming that the company gives 70% exposure to the pledged pool, the investor would get about Rs 21 lakh at about 13.5-14% floating interest per annum. The investor can now increase his market exposure from Rs 30 lakh to Rs 51 lakh (the pledged portfolio + the loaned amount).
On the face of it, this may sound a bit strange. It is mostly risk-averse investors who put their money in mutual funds. It is hard to imagine why such an investor would want to take on additional risk by leveraging his portfolio.
“Portfolio leveraging by mutual fund investors is not rampant, but is certainly picking up,” said an official at a brokerage house. “And it is not that investors always deploy the borrowed funds into stocks; often they reinvest the entire amount into mutual funds,” he added.
Investors prefer NBFCs when they want to raise funds by pledging their MF portfolios. While banks also offer the facility, they cannot lend more than Rs 20 lakh to an investor with the MF portfolio as collateral.
For portfolio leveraging to be attractive for an investor, the rate of return that he is making from stocks or MFs where he has invested afresh, should be significantly higher that the cost of borrowed funds. For instance, if the investor is borrowing money at 14%, he should at least be making 20% plus on those funds. With the market staging a near one-sided rally between August 2006 to July 2007, portfolio leveraging seemed to be the easiest way to maximise returns. But things have changed dramatically since the second week of August. The market has fallen nearly 13% from its peak, in line with the turmoil in the global equity markets.
And while it may have recouped most of the losses over the past one week, it is a clear reminder to investors like Mr Batra that making money through leveraged positions is not a one-way street.
5 Sep, 2007, 1020 hrs IST,Shailesh Menon, TNN
MUMBAI: Shashank Batra (name changed), a Mumbai-based businessman, has been investing in mutual funds for the past eight years, and now has a mutual fund portfolio of about Rs 1 crore. Apart from this, Mr Batra also likes to dabble in stocks whenever he gets some “hot tips” from his broker. Of late, he has been reluctant to put fresh money into stocks. That is when a relationship manager at a brokerage house introduced him to the concept of borrowing funds through ‘portfolio leveraging’. The idea appealed to Mr Batra, who gave his go-ahead to the relationship manager to arrange for funds by pledging his mutual fund portfolio.
Mr Batra is not an isolated instance. An increasing number of high net worth individuals (HNIs), who have sizeable holdings in mutual funds, are said to be borrowing money through portfolio leveraging. Under portfolio leveraging, the investor pledges his mutual fund portfolio (or share portfolio) to raise a loan.
Suppose, the investor has a mutual fund portfolio worth Rs 30 lakh, he’ll pledge the whole lot with an investment company, mostly non-banking financial companies (NBFCs), to take a loan. Most firms give 60-70% exposure on the portfolio pledged.
Assuming that the company gives 70% exposure to the pledged pool, the investor would get about Rs 21 lakh at about 13.5-14% floating interest per annum. The investor can now increase his market exposure from Rs 30 lakh to Rs 51 lakh (the pledged portfolio + the loaned amount).
On the face of it, this may sound a bit strange. It is mostly risk-averse investors who put their money in mutual funds. It is hard to imagine why such an investor would want to take on additional risk by leveraging his portfolio.
“Portfolio leveraging by mutual fund investors is not rampant, but is certainly picking up,” said an official at a brokerage house. “And it is not that investors always deploy the borrowed funds into stocks; often they reinvest the entire amount into mutual funds,” he added.
Investors prefer NBFCs when they want to raise funds by pledging their MF portfolios. While banks also offer the facility, they cannot lend more than Rs 20 lakh to an investor with the MF portfolio as collateral.
For portfolio leveraging to be attractive for an investor, the rate of return that he is making from stocks or MFs where he has invested afresh, should be significantly higher that the cost of borrowed funds. For instance, if the investor is borrowing money at 14%, he should at least be making 20% plus on those funds. With the market staging a near one-sided rally between August 2006 to July 2007, portfolio leveraging seemed to be the easiest way to maximise returns. But things have changed dramatically since the second week of August. The market has fallen nearly 13% from its peak, in line with the turmoil in the global equity markets.
And while it may have recouped most of the losses over the past one week, it is a clear reminder to investors like Mr Batra that making money through leveraged positions is not a one-way street.
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