I tend to leave my investments on auto-pilot, preferring to spend my time reading finance books to improve my lecture materials. So, it was very much of a shock to me when a student wrote to me informing me that Maybank Kim Eng had revised their grading system for EC World REIT from Grade A to Non-marginable. Making matters more exasperating, I remember my MKBE account manager telling me about how good EC World REIT was because they conducted a roadshow some time ago.
When engaged in leveraged investing, investors need to watch their margin account ratio very carefully and most of my ERM students are careful to keep it at 200%. If their portfolio falls in value by 30%, the margin account ratio will drop correspondingly. When it reaches a threshold of 140%, the investor will get a margin call from a broker and will need to urgently inject funds into their margin accounts to prevent the broker from liquidating their investments.
This downgrade came at a very bad time. A lot of margin account holders have been losing money since the COVID-19 outbreak and a downgrade like this would trigger many instances of margin calls.
Suppose, you are a margin investor (who did not attend ERM) but you kept two stocks in equal weights with a margin account ratio of 200%. If one of the stocks happen to be EC World, after the downgrade, your EC World REITs will not count towards your collateral value and your margin account ratio will drop by half. This can potentially reduce your ratio from 200% to 100%.
As we tend to leverage blue-chips and REITs in the ERM program, a downgrade from A to non-marginable status without an intermediate downgrade to B is unprecedented and urgent action is required. As the trainer, I do not have all the answers ready on such short notice, so I have to turn to the ERM Facebook group for mutual support.
After an intense pow-wow within the community, ERM students basically brainstormed a few options to respond to this situation:
a) Switch to margin account providers that still accept EC World REITs as collateral
The best practice is to manage more than one margin account provider. Stocks that are unacceptable to one broker may be acceptable to another.
So the second solution is to switch brokers. I have two leveraged accounts, Maybank Kim Eng and DBS Vickers. What I did in response to the news was that I sold my MBKE counters of EC World and bought an equal number of shares under DBS Vickers. This was not a completely savvy move as I lost $50 in brokerage fees and $200 from the bid-ask rate of the counter.
One hidden advantage, however, is that margin interest is lower under DBS Vickers.
b) Do nothing, top-up account to restore margin account ratio
I am grateful that I have very sensible students who suggested the most counter-intuitive answer to doing nothing. My students are conservative investors and tend to diversify very aggressively and the drop in that account ratios would be negligible. For students who insist on maintaining the ratio at 200%, all they had to do is to top up their accounts.
I also like this option because the broker does not get paid when an account gets liquidated.
c) Pivot to an equivalent counter
The community did not consider this option but I believe it’s worth considering this if this happens in the future to a different counter. If the downgrade were to happen to Keppel DC REIT, I might make a case to pivot to Mapletree Industrial Trust. If it happened to Capital Mall Trust, we can pivot to Frasers Centrepoint trust.
The problem is that EC World REIT invests in logistics properties in China. This makes it more or less a unique creature on its own. So right now, I doubt a truly equivalent counter exists.
If you push me for an alternative, perhaps a close equivalent would be Capital Retail China Trust, Sasseur REIT or even the next United Hampshire US REIT, but that’s stretching it in all three cases.
The bottom line is this.
Leveraging investing adds a whole new dimension to risk that is undertaken by the investor beyond the financial risk behind a stock counter:
- A counter’s grade can be amended triggering a small panic in the investment community.
- Dividends handling fee schemes can be revised or implemented.
- Interest rates can be amended upwards.
When this happens, having a community to discuss a possible action plan can significantly reduce the amount of stress to the investor.
The ERM Facebook group consists of 370+ alumni who have been trained in the basics of leveraged investing. 40% of active members claim to have a margin account and engaged in leveraged investing. Join our tribe!
