Citigroup’s 0.25% market-linked notes linked to two indexes, ETF offer coupon, full protection

By Emma Trincal

New York, Feb. 4 – Citigroup Inc.’s 0.25% market-linked notes due Aug. 27, 2021 linked to a basket containing two indexes and one exchange-traded fund provide full principal protection against market losses and a guaranteed coupon. This combination is not very common, financial advisers observed, noting however that the coupon size has little appeal.

Interest will be payable semiannually, according to a 424B2 filing with the Securities and Exchange Commission.

The underlying components are the Dow Jones industrial average, with a 33.34% weight, and the Nikkei 225 index and the iShares Core U.S. Aggregate Bond ETF, each with a 33.33% weight.

The payout at maturity will be par plus 100% to 120% of any basket gain, with the exact participation rate to be set at pricing.

If the basket falls, the payout will be par.

Tax treatment

Some advisers do not like full principal protection. Steve Doucette, financial adviser at Proctor Financial, said he is one of them.

“From my tax standpoint on principal-protected notes, everything in that note becomes ordinary income. I would probably give up a little bit of downside protection to increase the leverage on the upside,” he said.

“That’s one thing I don’t like about these deals: the tax treatment.”

Most 100% principal-protected notes require investors to recognize interest income during the life of the notes even if income is not received.

Country bet

The underlying basket is also an issue as it mixes various asset classes that Doucette said he would prefer to keep separate.

“We asset allocate, so we would do different notes in different indexes. I haven’t seen those three aggregated together. You’re looking at a globally diversified portfolio,” he said.

However, the only international allocation is the Japanese equity component, which makes for a third of the basket. The other two-thirds are U.S. stocks and bonds.

“You’re taking [a] country-specific bet. You may have international equity exposure, but if it’s all in one country, that’s not much diversification.”

Interest rate risk

The bond component, the ETF that tracks the U.S. investment-grade bond market, does not meet his current needs.

“We’ve been staying away from bonds because at some point interest rates are going to rise. We’ve looked at alternatives in the bond space that are not interest-rate sensitive. That’s how we typically use autocallables,” he said.

Doucette said he uses structured notes as a “replacement” for a specific asset class.

“We buy replacement for U.S. equity exposure, replacement for bond exposure and replacement for international equity exposure. Yes, Japan has done well, and they have been outperforming. I don’t think I would want to ride that particular horse right now. I’d rather get broader international market exposure.”

Dow, Nikkei

Jerry Verseput, president of Veripax Financial Management, was not impressed by the coupon rate.

“Oh! You can buy a cup of coffee,” he said.

He also objected to the components of the basket.

“The Dow Jones is not very representative of the U.S. market. It’s a price-weighted index of 30 stocks. I’d rather see the S&P 500 be the underlying,” he said.

The choice of Japan is not necessarily helpful for a U.S. financial adviser as the asset class is not well known.

“The Japanese index is a little bit exotic,” he said.

“Nobody follows the Nikkei. Clients are not familiar with Japan. If at the end it goes bad, they won’t understand how it happened. You might get bit by that one, and clients are not going to be happy.”

Drag on returns

Verseput saw little benefit in including the bond component in the basket.

“They throw in corporate bonds. You’re not going to get any principal growth from that allocation as interest rates are likely to go up,” he said.

“Two-thirds of your investment is exposed to stocks. The other third will sit there. It’s just an anchor.

“If I invest in stocks, I’d rather have a 100% exposure to stocks.”

The notes do not pay the dividends paid on the stocks included in the two equity benchmarks, according to the prospectus, which is common to almost all structured notes. Investors in the same fashion do not receive interest payments on the bonds held by the iShares Core U.S. Aggregate Bond ETF. The ETF carries a 2.27% yield.

“You’re not getting paid the yield of the bond fund. That’s probably how they can pay you the 0.25% coupon, but it’s a meaningless coupon,” he said.

“I have no idea why they would put it there. I’d rather have no coupon and get extra leverage.”

Citigroup Global Markets Inc. is the underwriter.

The notes will price Feb. 24.

The Cusip number is 17298C6Y9.

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