JPMorgan’s 6.3% yield notes on Russell, MSCI EAFE index seen as hard to allocate

By Emma Trincal

New York, Feb. 18 – JPMorgan Chase Financial Co. LLC’s 6.3% yield notes due Feb. 23, 2022 linked to the lesser performing of the Russell 2000 index and the MSCI EAFE index offer a fixed coupon and hard buffer for investors seeking above-average income, advisers said.

Yet the rate of return is not enticing enough for the risk taken, they noted. Moreover, the notes would be difficult to position in a portfolio due to their risk-adjusted profile, they said.

The notes will pay at least 6.3% per annum payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

If the final level of each index is greater than or equal to 80% of its initial level, the payout at maturity will be par plus the last coupon. Otherwise, investors will lose 1.25% for every 1% that the lesser-performing index declines beyond 20%.

Not a bond replacement

One challenging aspect of investing in the note would be to decide where to put it in the portfolio, said Steve Doucette, financial adviser at Proctor Financial.

“If you’re going to do a fixed-income substitute on this, you’re still subjecting yourself to possible losses,” he said.

Both interest payments and the 20% buffer were designed to mitigate the risk.

“You’re really protected up to a 26% loss, and that’s not bad,” he said.

But it would not be enough for a bond portfolio.

“If you go down 35%, and that’s possible, you’re still losing money even with the buffer.

“Your losses are buffered. But it’s not fixed-income. A double-digit loss is not a bond replacement,” he said.

A 35% decline in the price of the worst-performing underlying index would generate an 18.75% loss after applying the 1.25 x multiple associated with the buffer. The 6.3% coupon payments would cushion the loss amount causing investors to effectively lose 12.45% of their principal instead of 35%. They would earn nothing after one year.

“I’m trying to rationalize where to put this type of note in the allocation,” he said.

Risk profile

Doucette compared the risk with a bond exposure.

“If interest rates rise, your bond goes down in price. But even if rates go way up, you’re not going to lose anywhere near what you could lose from the equity exposure, especially if it’s a worst-of,” he said.

“Your protection stops at some point. After a 26% decline, that’s the crossover point.

“You could be down a lot. We don’t know.”

The downside risk of a bond holding compares much better, he added.

When interest rates rise, investors seeking to sell their bonds must discount the price in order to offer returns comparable with newly issued bonds. But over a short duration, the discount would be limited.

“You wouldn’t lose that much,” he said.

Any long-term bond fund would have a lot more risk, he added.

Of course, the key risk factor would be the amount of interest rate increase in the course of the next year.

Here again, Doucette saw limited risk.

“I don’t even see rates going up 1%, 2% or 3% with the Fed keeping rates low,” he said.

A bond exposure even with interest rate risk was considerably more conservative, he concluded.

“Six percent is a nice coupon. But I just don’t like the risk return,” he said.

Not enough protection

Others had similar views.

“Given how volatile the market is, what you’re getting in return is too low,” a buysider said.

If the note was a pure bond with full repayment of principal at maturity, the coupon would be exceptionally enticing, he said.

“But here you’re taking a huge risk on the downside. The Russell declined 45% a year ago,” he said, pointing to the pullback that began mid-February of last year, which saw the small-cap benchmark drop 43.5%.

“The amount you’re getting on the upside is clearly not enough for the risk you’re taking.”

Asset allocation

Matt Medeiros, president and chief executive of the Institute for Wealth Management, also criticized the risk-adjusted return as well.

“I do like having a guaranteed coupon, but I’m still exposed to equity risk,” he said.

“With a 6.3% return, I have upside risk. I’m capped at 6.3%.

“I also have a lot of downside risk. In theory I can lose my entire principal.”

A straight buffer would go a long way to attenuate the risk, he noted although it may not be sufficient.

“I don’t see 6% as an appropriate return for me to take this type of equity risk.”

The asset allocation dilemma was a concern as well.

“I’m getting a low return. Therefore, it should be allocated to a lower risk bucket. But it’s not low risk. So, I can’t really put it in my fixed-income bucket.

“There is equity risk, but the return is too low for an equity investment. So it doesn’t really belong to my equity bucket either.

“I really don’t see how this note would fit in my portfolio,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

The agent is J.P. Morgan Securities LLC.

The notes were expected to price on Feb. 17 and to settle on Feb. 22.

The Cusip number is 48132R5X4.

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