The strategy: To ramp up my T3 exposure.
Do I want to do that? You'd have to be pretty
gung-ho on Telstra's prospects to want to gear into T3 but then
some people are. And products are fast appearing to help them do
just that.
What sort of products? The two main options are
margin loans and instalment warrants, though providers are also
offering more highly geared T3 exposure through products such as
trading warrants and contracts for difference (CFDs). These
products are not new: you can use them to invest in most major
stocks. But T3 is already a leveraged product - you're paying $2
upfront of about $3.50 worth of Telstra stock. So this is an
opportunity to further boost that leverage. That's both good and
bad. On the plus side, leverage will boost that much-touted 14 per
cent yield to even higher levels as you'll be putting up less cash
upfront. If Telstra's share price rises, it will also boost your
potential capital gains. But if Telstra's price falls, consider
this. T3, as a leveraged exposure to Telstra, will fall by a
greater extent than Telstra and the potential losses on any
leveraged T3 product are even greater.
How does it work? Let's look at margin loans
first. Say you have $5000 to invest in T3. One margin lender,
CommSec, will lend up to 75 per cent of your purchase price if you
include T3 in a wider portfolio for the loan, or 70 per cent if you
want to borrow against T3 alone. So you could use the loan to buy
$20,000 of T3 instalments.
If T3 pays its forecast dividend of 28 cents next year, that's a
franked income of $2800 on the T3 holding. Even after allowing for
interest on the loan at 8.65 per cent (or $1297.50 in the first
year), you'll have about $1500 of positive cashflow versus $1400 if
you'd just invested your $5000.
The dividends should also carry about $1200 of franking credits
and you should generally be eligible for a tax deduction on your
interest costs, leaving even more extra cash in your pocket.
Of course, if you held onto T3 for 18 months, you'd still be
liable for the second instalment, plus the eventual repayment of
the loan.
Instalment warrants work on a similar principle. But instead of
you borrowing the money (and exposing yourself to margin calls if
T3's price falls), these products are internally geared.
One issuer offering a range of T3 instalments is Macquarie Bank.
Pia Cooke, from Macquarie's Equity Markets Group, says it has
developed a range of instalments for short, medium and longer term
investors.
Depending on which product you choose, their maturity date will
give you exposure to one, two, or all three of T3's dividends.
She uses the example of an investor who wants to boost their
return from only one dividend - the first dividend due to be paid
next February.
Instead of paying $2 for T3 instalments, you can pay 82.5 cents
for a Macquarie T3 instalment maturing in March. If you have
$50,000 to invest, that means you're getting exposure to 60,606
underlying T3 instalments, versus 25,000. If, as expected, the
February dividend is 14 cents, the investor in the Macquarie
instalment will receive $8485 of dividends plus $3636 of franking
credits - versus $3500 and $1500 with the straight T3 investment.
Even after allowing for $4563 of interest and put costs on the
investment (which protect you from losing more than your original
investment), you receive grossed-up income of $7558 v $5000 from
T3.
The costs and initial instalment warrant payments depend on the
product chosen and the maturity date.
Cooke says Macquarie also has five-year self-funding instalments
for longer-term investors who want to defer the second T3
payment.
Macquarie uses the example of an investor with $50,000 who pays
$1.65 upfront for a five-year instalment and borrows 50 cents. By
using the instalment he is able to get exposure to 30,275
underlying T3 securities, versus 25,000.
With this product, the dividends are applied to reducing the
loan and when the second T3 instalment is due, this is
automatically added to the loan amount. No further payment is
required until the instalment matures.
