Gearing instruments move into new era - BJM PCS

Gearing instruments may currently have a bad name, but they are still a good move when structured correctly for much-changed circumstances, according to financial sector trend-spotters at Barnard Jacob Mellet Private Client Services (BJM PCS), a leader in customised solutions for a top-end clientele.

In recent months, BJM PCS has noted ¡¥back-to-the-future¡¦ developments across gearing structures that reposition these mechanisms as prudent methods of mitigating portfolio risk or pursuing long-term value opportunities ¡V their traditional role.

A weaker share market has exposed the risk of using special vehicles to house shares pledged against a cash loan that might have been 10 times the value of the shares at the time of the transaction.

Benefits included favourable rates of interest, perhaps at the inter-bank rate, and the assurance of confidentiality as the transaction was between an individual and a broker or institution and not through a regulated exchange.

The danger was that individuals could suck out all available cash to fund extravagant lifestyles or to make aggressive plays in a market that was turning against them.

¡§Those days are gone,¡¨ says Nick Kunze, Relationship Manager at BJM PCS. ¡§Clients still request assistance with hedging or derivate-based structures of this kind ¡V but the underlying motivation has nothing to do with aggressive market tactics or cash extraction.¡¨

BJM PCS advises high net worth individuals and has long provided a well-regarded trading platform in Contracts for Difference (CFDs), a derivative that often underpins gearing instruments.

These products are relative newcomers to South Africa, but have been extensively used overseas for more than a decade and have been blamed by some for contributing to the speculator mind-set that fed the current financial crisis.

¡§Financial futures in various forms has been around for at least 350 years and cannot be blamed for today¡¦s financial malaise,¡¨ says Kunze.

¡§Lack of prudence and regulatory rigour were the culprits. These instruments can perform extremely worthwhile functions that help a wealth adviser achieve prudent, long-term objectives for a client.

¡§This is the current trend ¡V gearing to achieve a prudent outcome ¡V and we welcome it.¡¨

Portfolio balance to mitigate market risk might demand that additional commitments be made to cash while equity allocations are reduced.

Alternatively, capital might be needed by a client to secure a value opportunity such as a property purchase at a greatly reduced price for cash.

In today¡¦s market, however, gearing up to a multiple of 10 is no longer possible, says Kunze. A multiple of three, or sometimes five, was much more likely as banks are increasingly cautious.

¡§We advise clients of the risks and emphasise the defensive role of these solutions,¡¨ says Kunze. ¡§Market volatility makes it imperative that structures like this are regularly reviewed. Without vigilance by specialists familiar with these instruments, risks can mount quite quickly, as recent international experience confirms.

¡§But with proper safeguards and discipline, the benefits can be substantial.¡¨