JPMorgan plans commodity-linked dual-directional notes; product reflects sentiment shift, advisor says

By Kenneth Lim

Boston, Aug. 4 - JPMorgan Chase & Co.'s new commodity-linked dual-directional notes reflect a generally more neutral view of the asset class, an investment advisor said.

"There will tend to be more interest in absolute return investments when there is concern that a particular market may not do so well," the advisor said.

JPMorgan links to commodities

JPMorgan plans to price a series of zero-coupon principal protected dual directional notes due Aug. 30, 2013 linked to a basket of three commodities and three commodity indexes.

The basket comprises a 25% weight in the price of WTI Crude Oil, and 15% each in primary aluminum, Copper Grade A, the S&P GSCI Precious Metals Index Excess Return, the S&P GSCI Livestock Index Excess Return and the S&P GSCI Agriculture Index Excess Return.

For each $1,000 par note, investors will receive at maturity their principal plus an additional amount. The additional amount will be equal to par multiplied by 1.2 times the basket return at maturity if the basket finishes above its initial level. The additional amount will be equal to par multiplied by 0.2 to 0.3 times the basket's absolute return at maturity if the basket finishes below its initial level. Investors will receive at least par. The downside participation rate will be set at pricing.

Notes suit uncertain investors

The JPMorgan notes are likely to appeal to investors who are uncertain about the direction of the commodity markets, the advisor said.

"What I see is a product that's designed for investors who are not sure about where commodities are heading," the advisor said. "You don't really need to take any view of the market. If you buy this, you're basically just hoping to get some kind of positive return even though you're not really sure where the market's going to end up."

Investors who are ambivalent about the commodities market are on the increase, the advisor said.

"At the start of the year, everybody thought commodities still had ways to go," the advisor said. "But since then we've seen cracks in the price of oil, the kind of nowhere-but-up sentiment isn't as strong now. I think there's more uncertainty now."

Potential returns relatively slim

But the advisor said the absolute return structure chips away at the potential profits for investors of the product.

"Keep in mind this is a five-year structure," the advisor said. "Assuming the basket goes up 15% in the next five years, you'll get 1.2 times of that, so that works out to about 7.5% a year, which isn't good, but it's not great. If the basket goes down by 15%, you'll get, assuming the participation is 0.25, your yield is less than a percent, which is terrible."

The downside participation rate allows investors to outperform a direct investment in the basket components, but it will not help them to perform better than risk-free investments such as certificates of deposits, the advisor said.

"That's always one of the problems with absolute return products like this," the advisor said. "They're offering positive returns even in a down market, but those returns aren't usually anything that you can brag about."

Investors who are able to take a view on the market can probably do better, the advisor said.

"If you think commodity prices are going to go up or if you think they're going to go down, this isn't for you," the advisor said.

"If you've done your research and you can take a position on where the market is going, then it might be better to give up some of that downside protection and going for a better return. If you're not sure where the market is going, maybe you shouldn't be investing in it yet. If you can't figure out where corn and soy and rice prices are going to be in five years, either invest in something that's just for one year, or don't invest in agriculture. Put your money in equity or bonds or oil instead of agriculture."

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