Is the ETF GEAR a good opportunity for long term growth and dividends?

Welcome to Finance and Fury, the Say What Wednesday Edition. This weeks question comes from Gab.

“I had a question regarding a leveraged ETF from Betashares called GEAR. It is designed to offer around 2:1 exposure to the ASX 200, with 0.8% management cost. Looking at the long term growth and dividends, it seems like an excellent way to get exposure to the market and bank in around 20% franked divided (at 107% ??). Also no margin calls …. Am I missing something? It seems too good!”

Not personal advice – Just general information

GEAR

1. The Fund is ‘internally geared’, meaning all gearing obligations are met internally by the Fund.
   1. How this works – combines funds received from investors with borrowed funds and invests the proceeds
   2. The Fund’s gearing ratio (being the total amount borrowed expressed as a percentage of the total assets of the Fund) is managed between 50-65%
   3. This is the LVR – rebalance the LVR to the middle of the range (i.e. 57.5%) whenever it reaches either the minimum 50% or maximum 65% threshold
      60. Current gearing ratio – 60.1% – As at 27 April 2020. Calculated as Fund borrowings divided by Fund total assets. Current Gearing Ratio is as at start of the above date and can be expected to vary throughout the day.
      61. Current gearing multiple – 2.5 – Represents the Fund’s approximate exposure, for the above date, to movements in the Australian share market (as measured by the S&P/ASX 200 index). For example, if the Fund’s gearing multiple is 2.1x, and the S&P/ASX 200 index goes up 1% that day, the Fund would be expected to go up approximately 2.1% that day.
   4. A LVR ratio of 65% means that for every $1 invested, an additional $1.86 is borrowed to invest (providing a gross exposure of $2.86 for every $1 invested)
2. What they invest in – passive investment strategy – ASX 200 Index
   1. broadly diversified share portfolio consisting of the largest 200 equity securities on the ASX by market capitalisation (as measured by the S&P/)
   2. designed to provide leveraged exposure to a passively managed portfolio of broadbased Australian equities. The Fund will gain its Australian equities exposure by investing in the constituents of the S&P/ASX 200 Index, weighted by market capitalisation
3. How it operates – they use just one lender to gear – Deutsche Bank AG as the Lender to the Fund. At the time of review, the Manager has disclosed the Fund’s borrowing cost as 1.85% p.a. – but their underlying costs are lower – MER at about 0.8%
   1. At the moment – a lot of gearing funds are cheaper – massively low cost to borrow due to lower interest rate environment –
   2. That is one thing to watch out for – if funding costs go up, the MER goes up quite a bit – these types of geared funds were sitting at between 3-6% not that long ago – so that would reduce future gains
4. Price movements – was at $94 – price currently at $13.76
   1. Did hit $10 at the bottom.
   2. But unlike margin loans – GEAR gives you the opportunity to make magnified gains when the Australian sharemarket rises, and vice versa.
5. Income yields – do look good at the surface level –
   1. Good dividend levels and also franking levels – but this is due to the gearing of the funds
   2. 12 month distribution yield – 16.7% – but grossed up including fanking credits = 24.4%
      2020. Figures based at 31 March 2020. Yield figures are calculated by summing the prior 12 month net and gross fund per unit distributions divided by the fund closing NAV per unit. Franking level is total franking level over the last 12 months – have the disclaimer of Past performance is not an indicator of future performance.
   3. They say their level of franking is 107.6% –
      1. Looks a little Skew due to the Gearing –
   4. Break it down – they are a passive index fund – in the ASX200 – what is the ASX200 dividend yield –
   5. What is the franking?
   6. Now apply the gearing ratios – 2.5 times the funds invested – It does amplify the incomes –
      1. ASX200 – about 5% p.a. = close to about 13%
      2. Franking – ASX has about 62.42% franking as well – so grossing this up allows for additional flow throughs for distributions
   7. comparisons in distributions –
      1. First of 2020 – $1.02 – 12.25% yield based around the lower price
      2. 2019 – $1.76 distribution – 13.43% yield
      3. 2018 – $1.65 distribution – 15.83% yield
      4. 2017 – $1.37 distribution – 15.27% yield
      5. 2016 – $0.94 distribution – 9.19% yield
   8. It is calculated as the difference between total Fund return and NAV return. NAV return is the change in the Fund’s NAV price. Total return is the NAV return plus reinvestment of all distributions back to the Fund. Past performance not indicative of future performance.
   9. Good incomes – but the total returns need to also be looked at –
      54. 3m – negative 54.39% – 1y is about negative 45% – but the average annual return is -9.01%
      55. These include the distributions though – quoted returns = Returns are assuming income is reinvested – and does not take into account tax
   10. Returns have two components – incomes and growth = total return –
       1. Capital growth versus income –
       2. Distribution on income – taxable – but do get the franking credits to offset this – so in a lot of cases – taxable incomes of about $40k and above would result in net 4.5% tax payable
   11. Exchanging growth for income which gets taxed
       1. Reduces the yields a bit when breaking it down –
   12. Is it a good time to buy? It is all relative – good to time buy compared to 3 months ago? Yes
       1. 3 months from now- maybe not –
   13. Would caution against it for now – likely the ASX isnt through the woods –
       1. In addition – the growth returns on geared funds at this stage do have some longer term upside
       2. But overall – When it comes to geared funds – they are ones that do almost need to be timed to work well –
       3. Typically invest when the market is low – avoid buying when funds are slightly higher
       4. The returns are amplified but the issue is that the losses are amplified
       5. You lose 50% – you have to make 100% return back to original value
   14. Whilst geared – one or two bigger declines in a decade – which can happen – wipe out potential growth returns –
   15. As can be seen now – has a negative return since inception – and this includes the distributions being reinvested
   16. Also – if the funding rate costs do go up – could result in lower payments of distributions

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