Understanding Investment Financing

What is Investment Financing?In investment financing, you borrow money from a bank to invest. That loan is secured by your bank-managed assets acting as collateral, which may include deposits, stocks, bonds, funds, and other investment assets.In assessing whether an asset is a suitable collateral, we consider:

How easy is it to convert the asset into cash?

How volatile is the asset’s market value?

For bonds, what is the credit rating, or where there is no credit rating, the issuer’s financial strength?

Taking into account these factors, we derive the loanable value, or percentage of market value against which we lend you. The asset’s collateral value is then obtained by multiplying its market value with its loanable value.The collateral value must always be equal to or more than the loan amount.

Example:

Let’s say you believe Bond A presents an attractive investment opportunity. You have $1,000,000 in cash to buy Bond A. With a financing amount of $1,500,000, you can invest $2,500,000.

With a 60% loanable value, the collateral value of the bonds bought is: $2,500,000 x 60% = $1,500,000

This exactly covers the loan amount.

For illustration purposes only.

In the event the collateral value falls short, you will need to either:Raise the collateral value by:

Topping up cash into your account

Transferring some acceptable collateral into the account

Selling some assets in the account

Converting the loan into the same currency as the collateral (if the loan is in a different currency)

OrReduce your loan exposure by:

Paying back the loan

Investment financing may carry significant risks and is not suitable for investors who do not comprehend it or are risk-averse.

How Leverage WorksInvestment financing can enable you to invest more capital than you have on hand — and potentially increase your investment return. This is also known as “leveraging” or “gearing”.However, do note that leverage is a double-edged sword. If the investments rise in value, your returns are magnified. But if the investments move adversely, your losses will also be amplified.

	With Investment Financing	Without Investment Financing
Own capital	$1,000,000	$1,000,000
Loan amount	$1,500,000	0
Total capital available for investment	$2,500,000	$1,000,000
Loan interest (p.a.)	2.6% (indicative) p.a. or $39,000	N.A.
If your investments rise in value	Capital gain 6% or $150,000 Return on investment $150,000 - $39,000 = $111,000 11.1%	Capital gain 6% or $60,000 Return on investment $60,000 6%
If your investments decline in value	Capital loss -6% or -$150,000 Return on investment -$150,000 - $39,000 = -$189,000 -18.9%	Capital loss -6% or -$60,000 Return on investment -$60,000 -6%

For illustration purposes only.

Potential Uses of Investment FinancingHere are some examples of how borrowing to invest can add value to your investment strategy.1. Fully invest your portfolio, while enjoying liquidity when you need itScenarioHolding cash in your investment portfolio to meet short-term liquidity needs.With Investment Financing2. Acting on investment opportunities quicklyScenarioYou have a fully invested portfolio. An investment opportunity in Company A arises, and you want to act quickly — but without selling existing investments to fund the purchase. Transferring funds from another bank may be too late.With Investment Financing3. Implement a core-satellite investment approachScenarioYou wish to implement a core-satellite approach, in which the “core” portfolio comprises globally diversified assets to be held over the long term, while the “satellite” portfolio is made up of short- to medium-term investments for tactical gains.With Investment Financing4. Leverage your investmentsScenarioYou wish to invest more than you have, and can withstand the potential risks of gearing.With Investment FinancingYou can invest more capital than you have on hand. Please see example in “How Leverage Works”.

Risks of Investment Financing

	Without leverage, you may lose, at most, all your investment capital. With leverage, you risk losing more than your capital.
	Collateral shortfall occurs when the collateral value of your portfolio falls below your loan amount. When this occurs, you have to top up your account or transfer in more collateral within a short time. Otherwise, you may be forced to sell some or all the investment assets in your account, and this may occur when asset prices are unfavourable.
	If interest rates rise, you will have to pay higher interest on the investment loan.
	If the loan is in a different currency than your investments, you may face currency risk. Your loan repayment may increase if the loan currency appreciates against the investment currency.