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When to use debt to invest

The Financial Post takes a weekly look at tools and strategies that will help make your investment decisions. This week: leveraged investing

John Shmuel • Financial Post

Published Jun 04, 2014

Improving risk and return for a family enterprise

At a time when many retail investors are still hesitant to buy stocks, discussing leverage has become almost taboo, but that is not the case for the investment industry. Leveraged investing has never been more popular, as recent data shows. The Investment Industry Regulatory Organization of Canada (IIROC) notes that monthly client debt margin accounts hit almost $17.5-billion at the end of March, the highest on record and up from $16.4-billion at the end of 2013.

Investors using leverage expose themselves to possibly amplified returns, but also amplified risk. The most popular route is borrowing on margin — borrowing money from an investment broker to buy equities and then using them as collateral, which enhances purchasing power without the need to use your own money.

Arthur Salzer, chief executive at Northland Wealth Management in Markham, Ont., said using leverage makes sense for high-net worth clients comfortable with taking on risk, especially since Canadian tax policy allows some types of leveraged investing that produce income to be tax deductible.

But he would probably advise an average retail investor — someone who has an investment portfolio of $50,000, for example, and still has a mortgage — not to use leverage.

“The price swings in the public markets can be so severe that someone might measure the loan versus the current market price and market value of the portfolio and they might liquidate at the wrong time,” Mr. Salzer said. “It puts too much inherent stress and emotion on the individual.”

Another issue to consider is just how popular leveraging as an investment strategy has become this year.

Pierre Lapointe, head of global strategy and research at Pavilion Corp., notes that margin debt on U.S. trading accounts is now much higher than it was during the I.T. bubble or before the financial crisis. IIROC data shows the situation in Canada is similar.

But highly leveraged traders are not necessarily a reason to stay out of the stock market or to avoid going down that route. “Margin debt seems to be purely a coincident indicator,” Mr. Lapointe said. “If the rally continues, margin debt will go even higher.”

He notes, however, that if stock markets do pull back, margin calls — or brokers demanding that investors put more money into their portfolios to cover potential losses — will “probably exacerbate the move on the downside.”

That is a big risk for anyone thinking of leveraging to invest, Mr. Salzer said.
“It doesn’t mean the market is going to crash, but it does mean people are being greedy,” he said. “There are two cycles markets go in: fear and greed. We’re in the greed phase now. That just means investors need to be careful, because if there is a shock, such as an unexpected geopolitical event, that ripple can turn into a wave much quicker by having a high amount of leverage.”


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