Advisors can lend clients a hand in managing their debt as well as their financial assets by arranging loans for investment fund purchases. Such loans can save clients the time and trouble of applying for loans at regular financial institutions, and are available with attractive variations such as “no margin call” and interest-only features.

“The ability to arrange an investment loan is an important part of the suite of tools that advisors with ‘holistic’ practices can offer clients,” says John Bennett, executive vice president of AGF Trust Co. in Toronto. “If the client is a suitable candidate for an investment loan, judicious use of leverage can build assets more quickly. And that helps advisors build their books of business.”

An investment loan allows a larger amount of money to be invested at once, offering the potential of generating a larger long-term return than by adding to the investment pool gradually. Another advantage is tax-deductibility of interest on the loan. By reducing the after-tax cost of the loan, the chances increase that the leveraged investing may outperform traditional investing.

However, clients need to be made aware that investing is a double-edged sword: the larger the amount invested, the greater their losses will be in down markets.

Companies offering investment loans through advisors report a strong rise in this line of business as clients take advantage of the ability to apply from the advisor’s desk and one-day processing of online applications. A handful offer loans via advisors, including AGF Trust; TD Canada Trust; MRS Trust Co., B2B Trust, a wholly owned subsidiary of Montreal-based Laurentian Bank of Canada; and Toronto-based Manulife Bank of Canada. All report the rate of growth in investment loans has been increasing rapidly in the past two or three years.

AGF Trust, for example, reported investment loan assets of $1.5 billion as of March 31 — almost double the $800 million of a year earlier. Bennett says recent low interest rates, as well as strong stock markets, have contributed to growing interest in leveraging strategies.

“The industry has grown hugely in the past three years,” says Jeremy Bird, senior managing director at TD Canada Trust in Toronto. “There are more players offering the loans and more people are hearing about them. As advisors who haven’t been using leverage become educated, they are educating their clients about the opportunity.”

Advisor-sold investment loans are typically offered to clients of advisors working for fund dealers and insurers, as large investment dealers offer their own margin loans. Investment loans can be used to buy mutual funds and segregated funds, as well as a handful of principal-protected notes. These loans are typically not available to buy individual securities, such as stocks and bonds. Advisors are not directly compensated, but receive trailer fees and commissions on fund assets sold to their clients.

Investment loans usually charge a floating interest rate. For example, AGF Trust charges prime plus 75 basis points for loans that are being repaid over a predetermined term by regular payments of principal and interest. If the loan is interest-only, AGF Trust charges prime plus 1.25% for loans of between $10,000 and $250,000, and prime plus 1% for loans of more than $250,000.

Investment loans have been given an extra kick with the easier availability of no-margin loans in the past few years, says Tricia Barry, vice president of B2B Trust in Toronto.

B2B Trust’s no-margin loans typically charge an interest rate of 25 bps more than margin loans, but they offer clients peace of mind because they won’t be subject to margin calls.

Essentially, a margin call means that if the value of the client’s leveraged portfolio declines, he or she must supply additional collateral in the form of funds or cash to replace the lost capital and bring the level of assets pledged to the lender back to the original loan/value ratio. If this collateral is not available, clients may be forced to sell assets or somehow find the funds to bring their loan/asset ratio back into line. Unless the client can easily come up with the cash to meet a margin call, a no-margin-call feature is safest, Barry says.

“With the no-margin product, clients can sustain a decline and wait for a market rebound without having to worry about a margin call or a forced sale of assets that would interrupt the growth pattern of their investments, and possibly lead to selling at an inopportune time,” she says.

@page_break@B2B Trust offers three investment loan products:

> a two-for-one product, in which B2B Trust lends $2 for every $1 of funds held by the client;

> a one-for-one product, in which B2B Trust will match every dollar put up by the client;

> a 100% loan that fully finances new investment purchases and uses the investment as collateral.

Pricing depends on the amount of collateral supplied for each type of loan, but all these loans are available to a maximum of $250,000 and can be obtained on either a “no margin call” basis or with the lower-priced margin-call feature.

Clients could apply for loans of more than $250,000, but they would require additional documentation and the turnaround time would be longer than the single day required for smaller loans, Barry says. Little documentation is required for loans of less than $50,000, which require no proof of assets or income for salaried employees.

In addition to lending money to purchase mutual funds through financial advisors, B2B Trust also works with a handful of fund companies, including AIC Ltd. of Burlington, Ont., and Fidelity Investments Canada Ltd. and CI Investments Inc. , both based in Toronto, to package fund company-branded, advisor-sold loans to clients wanting to stick to a firms’ specific line of funds. These one-family loans are typically available at a 50-bps discount to the interest costs on B2B Trust’s regular multi-fund family loans.

“The majority of borrowers choose interest-only loans,” says Bennett. “They can pay off the loan at a future date when the assets have increased significantly, or redeem it gradually when they have extra cash. Why pay off tax-deductible debt when other debt such as mortgages are not tax-deductible?”

MRS Trust has a no-margin-call loan with one- or two-year amortizations available for a $1,000 minimum investment. It also offers its Wealth Builder Investment Loan, suitable for those who don’t own securities to put up for collateral and for clients who will be borrowing 100% of the purchase price. Like B2B Trust, MRS Trust’s two-for-one loan is suitable for those who want to employ varying amounts of leverage, but borrowing is limited to twice the amount pledged in cash or existing investment funds. Margin-call and no-margin-call options are available on all MRS Trust loans.

Typically, none of the lenders charge a penalty for paying off loans early. Most lenders suggest borrowers have a horizon of at least 10 years, a well-diversified portfolio and sufficient income to service the loan’s interest payments comfortably. If the investment is held outside an RRSP, it could generate income taxes on dividends and interest received within the fund, as well as capital gains. Clients should be prepared to pay these annual taxes.

A popular strategy is converting a monthly automatic mutual fund contribution plan into a lump-sum borrowing program that results in the monthly interest payment on the loan being roughly the same amount as the previous monthly fund contribution. Instead of putting $300 a month into mutual funds, the client could borrow $50,000 and carry an interest-only loan for $292, based on a 7% interest rate. The client benefits from the tax deductibility of interest on the investment loan, which could reduce the after-tax interest cost by almost half for those in the top tax bracket, and also enjoys compound growth beginning immediately on a $50,000 lump sum rather than slowly building up that amount.

“We don’t recommend borrowing for clients with short-term time horizons or low risk tolerance,” says Scott Bergen, product director for Manulife Bank, which offers loans only for Manulife products. “But leverage is a good way to take advantage of the long-term upward bias of financial markets, and can provide better growth than dollar-cost averaging.” IE