Super gives you something most other investments don’t: time. If you’re in your 20s or 30s, you could have several decades before you need to start drawing on it. That makes it possible to take a different approach to risk than you might with money you’re planning to spend in the next few years.
For some investors, that means using gearing.
Gearing lets you get more exposure to the share market than the amount of money you’ve actually invested. The upside is obvious enough: if markets rise, you can potentially make more than you would have without the extra exposure. The downside is just as important: if markets fall, your losses can be larger too.
You can use a margin loan to gear your investments, but there’s another way to do it that doesn’t involve taking out a personal loan. Internally geared ETFs do the borrowing inside the fund itself, which means you can get geared exposure simply by buying units in the ETF.
So how does it work, and could it make sense inside super?
So, what is a geared ETF?
Let’s start with the basics. An ETF is a fund that holds a collection of investments, such as shares, and trades on the ASX like a share. A geared ETF does something a little different: it borrows money to increase the amount it invests.
Say you put $10,000 into a geared ETF. The fund can combine your $10,000 with borrowed money and use the larger pool to invest in shares. If those shares rise, you get the benefit of having more money invested. If they fall, you wear a larger loss. Funds such as Betashares GEAR and GGUS use this approach to provide geared exposure to Australian and US shares respectively.
The other important thing to understand is where the borrowing happens. With a margin loan, you personally borrow money to invest. With an internally geared ETF, the fund pools investors’ money, borrows additional funds and uses the combined amount to buy more assets. You simply buy units in the ETF, as you would any other ETF.
That means you don’t have a personal margin loan or a margin call if markets fall. It doesn’t mean the investment is protected from falling markets, though. The gearing still means the fund is more exposed to market movements.
Why consider gearing in super?
The main attraction of gearing is pretty simple: it gives you more exposure to the share market without having to put up all of the capital yourself.
Super can be an interesting place to consider this because of its long investment timeframe. Someone with decades until retirement has more time for a long-term investment strategy to play out than someone investing money they’ll need in the next few years.
There are also tax considerations. Investment earnings in the accumulation phase of super are generally taxed at 15%, while eligible capital gains on assets held for more than 12 months receive a CGT discount, giving an effective tax rate of 10% on those gains. That can make the tax treatment of investing through super different from investing in your own name.
None of this makes gearing a free lunch, though. The same leverage that increases your exposure when markets rise also increases your exposure when they fall. The question is whether the potential benefit of having more money invested is worth taking on those larger swings.
How to invest in a geared ETF through super
If you want to hold a geared ETF in super, you need a self-directed super account that lets you choose and trade individual ETFs.
For example, with a platform such as Pearler Super, you can select a geared ETF from the available investments and buy units using money in your super account, just as you would when investing in an ETF outside super.
SMSF members can also invest in geared ETFs, provided the investment is permitted under the fund’s investment strategy and the relevant superannuation rules.
The gearing itself happens inside the ETF, so you don’t need to arrange a separate loan or borrow against your super balance. The main thing to check is that the ETF you want is available through your super platform.
A word of caution: a 2x ETF doesn’t simply give you 2x the return
This is one of the more important things to understand before buying a geared ETF. A fund targeting 2x exposure isn’t promising to deliver twice the return of an index over 10 or 20 years. The gearing applies to the fund’s daily movements.
Why does that matter? Because markets don’t move neatly upwards. They go up, down and sideways, sometimes within the same week. Say an index falls 10% one day and then rises 10% the next. It hasn’t quite made it back to where it started. In a geared fund, those movements have a larger impact because the fund has greater market exposure.
Over time, this can lead to what’s known as volatility drag. The return you actually get from a geared ETF can be quite different from simply taking the underlying index’s return and multiplying it by two.
There’s also the cost of borrowing. The fund pays interest on the money it borrows, and those costs come out of the fund’s returns. So the “2x” figure doesn’t tell you what you’ll earn over the long term. It tells you something about the level of market exposure the fund is targeting.
What happens when markets fall?
The easiest time to think about gearing is when markets are going up, but the harder question is what happens when they aren’t. A geared fund can fall considerably more than the underlying market during a downturn. A big fall also leaves the investment with further ground to make up before it gets back to where it started.
That can be uncomfortable at the best of times. Inside super, the timing matters too. A large fall shortly before you start taking money from super can leave you with less room to recover. And because the investment is geared, the fall can be larger than it would have been in an ungeared investment.
This is sometimes referred to as sequencing risk. When you’re accumulating super, the order in which good and bad returns arrive generally matters less than it does once you’re relying on the portfolio to fund your spending.
That’s one reason gearing needs to be considered alongside your retirement timeline, rather than just the potential return of the ETF.
What happens as retirement gets closer?
The question then becomes what role, if any, you still want gearing to play as you approach retirement.
Your super investment portfolio doesn’t have to stay exactly the same throughout your working life. As your circumstances change, you might decide that you want less exposure to investments capable of producing large swings. That could mean reducing a geared allocation over time, rather than making one big change when you retire.
There’s no universal age at which this needs to happen. It depends on how much of your retirement income you’ll need from super, what other assets you have and how comfortable you are with market volatility. The important thing is to have thought about it before you’re in the middle of a market downturn and wondering whether the level of gearing still makes sense.
You don’t have to gear your whole portfolio
There’s also no rule saying that if you want gearing, you have to gear everything. One approach some investors use is to make a geared ETF a smaller part of their portfolio, alongside broader, ungeared investments. The geared investment can then increase the portfolio’s overall exposure to the market without making the whole portfolio dependent on that extra leverage.
There’s no magic percentage that works for everyone. The appropriate allocation will depend on the rest of the portfolio, your tolerance for losses and how much risk you’re prepared to take.
It’s also worth looking at what you’re already invested in. If you have a portfolio that’s already heavily exposed to Australian shares, for example, adding a geared Australian equity ETF isn’t diversifying that exposure. It’s increasing it. The same applies to other investments. Before adding a geared ETF, it helps to look at the portfolio as a whole and understand how much market exposure you’re actually taking on.
And if you decide later that you don’t want as much gearing, it’s easier to change one part of the portfolio than to unwind an entire strategy built around leverage.
Before you buy one
Geared ETFs can look deceptively simple. You buy units on the ASX, just like you would with an ordinary ETF – but what’s happening inside the fund is more complicated. Before adding one to your super, a few questions are worth asking.
1. How long until you need the money?
Your investment horizon matters because it affects how much time you have to deal with a bad run in markets.
2. How would you handle a big loss?
A geared investment can fall much faster than the underlying market. It’s worth thinking about how you’d react if the balance dropped substantially, rather than judging your risk tolerance based on what happens during a rising market.
3. What else do you own?
Look at the whole portfolio. A geared ETF can increase your exposure to a market you’re already heavily invested in, so make sure you understand what you’re adding.
4. What happens later?
If gearing is part of your strategy while you’re younger, think about whether you’ll still want that level of risk as retirement approaches.
Gearing isn’t a shortcut to higher returns. It’s a way of taking on more market exposure, with the potential for higher returns and larger losses along with it. For some investors, that may be a reasonable trade-off. For others, the additional volatility and complexity won’t be worth it.
The key is understanding what the gearing is doing before you decide how much of your super, if any, you want to put behind it.
Disclaimer: This article is general in nature and has been prepared without taking into account your individual objectives, financial situation, or needs. It does not constitute financial or tax advice, and nothing in it should be relied upon as a recommendation to buy, hold, or sell any financial product. Geared ETFs carry significantly higher risk than ungeared investments, including the potential for larger losses. Before making any decisions about your superannuation or investment strategy, please consider seeking advice from a licensed financial adviser who can assess your personal circumstances.
