An Internally Geared Managed Fund is a type of investment fund that uses internal borrowing to increase the amount of money that’s invested. In simpler terms, it means that for every dollar you invest, the fund borrows additional money to invest more than your initial contribution.
The rationale behind this strategy is that over the long term, the cost of interest on borrowed money is lower than the long term rates of return on growth asset classes like shares and property, and therefore, the differential creates extra returns.
In the chart below (credit: Vanguard) it is easy to see that long term growth asset classes like shares and property significantly outperform cash. Depending on the risk of the borrowing, debt is usually 1 to 4% p.a. higher than the cash rate.
Geared managed funds amplify both the gains and losses of growth investment returns. The following chart compares an ASX100 Index without gearing (orange line) versus the ASX100 Index with Gearing (blue line). You can see visually when markets are performing well, gearing amplifies returns, however when markets perform badly gearing amplifies capital losses.
So, who could potentially benefit from using Geared Managed Funds?
Those with a very long investment timeframe (i.e. those who do not need short term access to these investments) and high risk tolerance.
Those who want to benefit from gearing but may not be able to borrow in their own personal name due to serviceability or in superannuation due to the SIS act restrictions.
Those who wish to 'outperform' the market index.
Internally geared managed funds can be a useful way to added excess returns to a portfolio under the right circumstances. However, people need to be aware of the risks and additional investment costs before deciding to proceed with this strategy. If you would like to discuss whether this investment option could be right for you, you can book in an initial free chat below:
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