7A.8 Borrowing to Invest in UTS and the Risks of Loan Financing
Key Takeaways
Loan financing is allowed for UTS investment but not for PRS, and because of its risks the study guide says it is not encouraged.
The maximum loan-to-valuation ratio, or margin of finance, for a UTS loan is 67%, so an investor buying RM100,000 of units could borrow up to RM67,000.
Borrowers must be over 18 and should be under 55 at the end of the loan term, and monthly repayments do not normally exceed one-third of gross monthly income.
If a borrower defaults, the lender may sell the units at a time it chooses, and the borrower must pay any shortfall between the sale proceeds and the loan.
The study guide cites studies showing the chance of losing money on Bursa Malaysia can be up to 35% in any one year, 28% over two years and 21% over five years.
Why Investors Borrow
Chapter 2 covered lump sums, reinvestment and regular savings. Another method is borrowing (loan financing), allowed for UTS but not PRS, and not encouraged because of its risks.
Investors borrow to leverage (gear) their investment, hoping the fund's return will exceed the cost of borrowing. Lenders usually require some of the investor's own money alongside the loan.
Leverage in numbers (illustration)
An investor puts in RM30,000 of her own money and borrows RM60,000 at 5% a year, investing RM90,000 (loan share 66.7%).
| Fund return over one year | Value of units | Loan interest | Gain or loss on her RM30,000 |
|---|---|---|---|
| +10% | RM99,000 | RM3,000 | +RM6,000 (+20%) |
| 0% | RM90,000 | RM3,000 | −RM3,000 (−10%) |
| −10% | RM81,000 | RM3,000 | −RM12,000 (−40%) |
Charges and taxes are ignored. Without borrowing, the same fund would have given her +10%, 0% or −10%. The loan stays the same while the units fall, so losses on her own capital are magnified, and if she must sell she has to repay the shortfall from other savings.
Typical Loan Features in Malaysia
| Feature | Study guide description |
|---|---|
| Lenders | Most banks and finance companies; often a panel of lenders approved for UTS financing |
| Term | Up to 10 years |
| Amount | Usually between RM10,000 and RM250,000 |
| Rate | Usually variable: the lender's Base Rate, Base Lending Rate (conventional) or Base Financing Rate (Islamic), plus a margin; generally higher than housing or personal loan rates |
| Maximum margin | 67% loan-to-valuation; RM100,000 of units allows a loan of up to RM67,000 |
| Age | Borrower over 18 and under 55 at the end of the loan term (income-earning years) |
| Affordability | Monthly repayments normally no more than one-third of gross monthly income |
The SC requires the UTMC to ensure Consultants do not encourage loan-financed sales, and the investor must sign the Unit Trust Loan Financing Risk Disclosure Statement (section 4.5).
The Four Risks of Borrowing to Invest
1. Interest rate fluctuations
Loans are usually at variable rates, so the total cost cannot be predicted and the expected profit after interest is uncertain.
2. Default in repayment
If the borrower misses repayments, the lender may liquidate the units, with or without consent, at a time the lender chooses, possibly at a market low. The borrower loses control of the sale and must pay any shortfall between the sale proceeds and the loan.
3. Premature repayment
The loan may run up to 10 years, but events such as job loss may force early repayment. The study guide notes that most loans repaid in the first five years suffer more losses than gains, citing studies that the chance of losing money on the stock market (Bursa Malaysia) can be up to 35% in any one year, 28% over two years and 21% over five years.
4. Margin call
If unit prices fall, the units held as collateral may no longer give the lender enough security, so it makes a margin call to top up the security. If the borrower cannot pay on top of normal instalments, the lender can force-sell units, possibly at the worst time.
How a margin call arises (illustration)
Suppose the loan agreement requires the units held as security to be worth at least RM1.30 for every RM1.00 of loan outstanding (lenders set their own levels; this figure is only for illustration). The investor borrowed RM60,000 and holds units worth RM90,000, so cover is 1.5 times.
| Market move | Value of units | Cover (units ÷ loan) | Result |
|---|---|---|---|
| None | RM90,000 | 1.50 | Within limit |
| Units fall 10% | RM81,000 | 1.35 | Within limit |
| Units fall 15% | RM76,500 | 1.275 | Margin call: top up about RM1,500 in collateral or cash to restore 1.30 cover |
If she cannot meet the call on top of her monthly instalments, the lender may force-sell units, locking in the loss at a market low.
Should an Investor Borrow?
Each case is different, but investors must consider the implications carefully. If an investor does not understand both the UTS investment and the loan, they should not borrow. The study guide suggests that Consultants may do better to recommend the regular savings method.
| Question to ask the client | Why |
|---|---|
| Could you keep up repayments if your income fell? | Default leads to forced sale |
| Could you meet a margin call from other savings? | Falling prices can trigger calls |
| Could you hold for the full term? | Early repayment raises the chance of a loss |
| How would a rate rise affect you? | Variable rates change the total cost |
Under the study guide's typical UTS loan terms, how much could an investor borrow to buy RM90,000 of units at the maximum margin of finance?
RM60,300
RM67,000
RM90,000
RM45,000
What happens if a borrower defaults on a UTS loan secured on the units?
The loan is converted into a contribution to the investor's PRS
The lender may sell the units and recover any shortfall
The Trustee repays the outstanding loan from the fund's assets
The UTMC must buy back the units at the original price
Which method of investing does the study guide suggest may be more prudent than borrowing to invest in UTS?
Investing through a wholesale fund
Investing a larger lump sum
Regular savings
Switching between funds frequently
Sections you finish are checked off in the contents.