JPMorgan to initiate the use of Edge MSCI Min Vol ETF in a structured note for lower-risk play

By Emma Trincal

New York, Sept. 13 – JPMorgan Chase Financial Co. LLC’s capped buffered return enhanced notes due Oct. 3, 2019 tied to the iShares Edge MSCI Min Vol USA exchange-traded fund marks the first use of this underlying fund in a structured note, according to data compiled by Prospect News.

The payout at maturity will be par plus 1.5 times any fund gain, up to a maximum return of 13% to 17%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the fund falls by up to 5% and will be exposed to any losses beyond 5%.

Performance

“This is kind of interesting,” a market participant said.

“I’m not familiar with this particular ETF. But it looks like it has been performing pretty well.”

The iShares Edge MSCI Min Vol USA exchange-traded fund seeks to track the performance of a U.S. equity index which has lower volatility characteristics relative to the broader U.S. equity market, according to the prospectus.

The ETF share price has more than doubled since its inception on Oct. 18, 2011.

Past returns

The ETF offers exposure to U.S. stocks with “potentially less risk,” according to BlackRock Fund Advisors, the advisor of the ETF, stating on its website that the fund has historically declined less than the market during market downturns. No historical performance data however is available for the last bear market of 2007-08.

“You can make the assumption that low volatility performance means less risk but that’s really just what history is telling us. Historically low vol. in a down market will outperform the overall market. But you still have downside risk,” an industry source said.

Mildly bullish

The 5% buffer in his view was more meaningful as a way to compensate investors for the loss of dividend income than it was as a protection feature.

The fund shows a 2% dividend yield.

“If you’re a little bit bullish but with lower expectations, this 15% cap is not bad. That’s 7.5% a year. On an historical basis that’s quite good,” he said.

He used a hypothetical cap of 15% at midpoint of the range disclosed in the prospectus.

“Do you expect the market to rise by 15% every year? No. So the leverage could help you get a decent return.

“It’s a fair bet. Is it amazing? No. But there’s definitely demand for low vol. as an asset class.

“You want to avoid losing money. But if you end up losing, you want to lose less than others,” he said.

Terms

The top three holdings in the fund are Becton Dickinson, McDonalds Corp. and Visa, Inc.

The historical volatility of the index over the last 100 days is only 6.2%.

“It’s pretty low, and that’s the whole idea. The implied volatility is probably low as well,” the market participant said.

For investors in the S&P 500 index, a 15% cap with a 2% buffer on a two-year note may not be enticing, he noted.

But the low volatility underlying fund cannot be compared to the overall market, said Suzi Hampson, structured products analyst at Future Value Consultants.

“When you expect your underlying to move less in either direction, your cap is going to be lower, your buffer is going to be lower,” she said.

Structuring a buffer requires selling an option for its premium.

“That put option is not worth a lot,” noted the market participant.

“That’s why they can’t give a big buffer. If you give a 10% buffer there’s not enough money to buy a decent call spread.”

Buffer or not

In his view the very existence of a buffer may not even be necessary as the chances of losses are considerably reduced with a low volatility reference asset.

“It’s a decent cap because it’s a question of risk. Your risk is not that much,” he said.

“A decline of 5% or more is not very likely by virtue of your underlying exposure. Low volatility equity isn’t going to decline as much as the S&P 500.

“In fact, I don’t know why they even bothered putting this 5% in there. Maybe they want that little extra as a selling point.

“But this product almost calls for no protection on the downside and more return on the upside.

“Regardless of that, the trade makes sense for some more conservative investors. It’s a safer play on the market.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes will price on Sept. 29.

The Cusip number is 46647M5L3.

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