JPMorgan's contingent buffered notes linked to Euro Stoxx 50 set to outperform in correction

By Emma Trincal

New York, March 27 - JPMorgan Chase & Co.'s 0% contingent buffered equity notes due Sept. 30, 2015 linked to the Euro Stoxx 50 index could outperform the euro zone blue-chip benchmark in the event of a dip or correction short of a bear market, sources said.

That is because the contingent buffer offers not just downside protection but also a minimum return, they noted.

If the index finishes at or above the 80% trigger level, the payout at maturity will be par plus the greater of the index return and the contingent minimum return, which is expected to be at least 3.1% and will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Otherwise, investors will be fully exposed to the decline in the index.

Relative performance

"If you look at the risk-return profile of the note, you're long the index on the upside and you're long the index on the downside if you breach the 20% threshold," said Steve Doucette, financial adviser at Proctor Financial.

"The only way you outperform the notes is when the index is down by less than 20%, when it closes in that 100%-80% range.

"If the Euro Stoxx drops 19.9% and you make 3.1%, your return may be 3.1%, but in relative terms, if you compare your return with the market, you're outperforming by 23%.

"That's why people would buy this note. What else would they be doing it for?

"If you anticipate a pullback not something as severe as a correction and you want a little bit of protection, the notes offer a neat way to outperform the market on a relative basis."

The upside is uncapped, but it also offers no leverage.

"There is no difference here between the notes and being long only," he said.

"Although it's nice to be able to keep up with the full upside, that's not where the value of the note is.

"We as professionals always look at returns relatively. This one can outperform on a relative basis. If your clients make 3% and the market is down 20%, they're going to like it."

Likely correction

Holding the view that the market may go through a correction is not unreasonable, he said.

"There is undoubtedly a high probability if you look at the history of the market that there will be a pullback within the next year or two. We're just entering into our sixth year of the bull market. On average, you get a bear market every five to six years," he said.

"But this note is tied to Europe, and things are a little bit different over there with Europe lagging the U.S."

The Euro Stoxx 50 index has gained about 50% in the past five years versus 125% for the S&P 500 during the same period.

"I probably would have liked the note more in the U.S. where we've already outperformed Europe and the chances of a pullback are greater. While there will probably be a reversion to the mean in both markets, you might be better off doing it in the U.S. now," he said.

Averaging

The calculation of the final index level is also something Doucette said is beneficial to investors.

According to the prospectus, it will be the average of the closing index levels on the five trading days ending Sept. 25, 2015.

"More issuers are doing the averaging at the end of the note. I wonder if JPMorgan didn't initiate the trend," he said.

"We did a note with them on their J.P. Morgan Strategic Volatility index, and they proposed that final averaging feature. We liked it because it makes sense. You can have the market up 1% and down 2% in just one day. The averaging tends to minimize losses, and I don't think it will take away a lot of the upside because you're not going to lose all of the upside in a few days.

"So we like those final-days averaging. Maybe issuers should look into that trend.

"But they need to cover more in range. How about averaging a few more days at the end or even weeks? I'm sure the averaging helps with pricing, so maybe they should do more. That's why we're paying these big guys the big bucks."

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said the minimum contingent return's main function is more to offset the loss of dividends than to generate outperformance. The Euro Stoxx 50 dividend yield is 2.6%.

In his view, the note offers investors a way to get exposure to the euro zone equity market with "a little bit of protection." But he is not comfortable with the weightings in the Euro Stoxx 50 index.

Too broad an index

"I like Europe as an allocation in the portfolio, but in this current market environment, I would prefer to go country-specific as opposed to buy the broader index," Medeiros said.

"I like some of the countries in the index, but it's weighted as such that you're going to get a portion of the countries that you don't want to invest in."

The index covers 50 stocks from 12 euro zone countries: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain.

The top country allocations are France and Germany with 36.51% and 32.4% weightings, respectively.

"I would prefer to be more focused on Germany and France only. Both may be the top country weightings, but you still have about a third of the index allocated to countries I would prefer to avoid, such as Italy, Spain, Netherlands and Belgium," he said.

Spain (12.27%) is the third country in the index, followed by Italy (8.37%), the Netherlands (6.91%) and Belgium (2.97%).

On the other hand, Medeiros said that the sector allocation of the index is "interesting," with the top weighting in financials representing a 27% allocation.

"I like that it's heavily weighted in finance. In particular, I like the French banks, even though there are some challenges in France," he said.

The contingent minimum return is "an interesting idea" and may "make up" for the loss in dividends, he said.

"I like that you're one-to-one on the upside without a cap. At least you're not going to lose on your return," he said.

"I don't believe that the Euro Stoxx performance is going to be as bullish as it was last year, though.

"But if you want exposure to the specific countries of this benchmark with a little protection on it, I think the structure is fine.

"It probably wouldn't be something that would reflect my views simply because I'd rather pick and choose the underlying countries."

The notes (Cusip: 48127DCH9) are expected to price Friday and settle Wednesday.

J.P. Morgan Securities LLC is the agent.

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