Citigroup’s barrier digital notes tied to copper, oil pay high yield but not enough for bulls

By Emma Trincal

New York, June 13 – Citigroup Global Markets Holdings Inc.’s 0% enhanced barrier digital securities due June 25, 2018 linked to grade A copper and crude oil futures offer an above average yield with reasonable downside protection, but bulls need not invest in this product due to the cap on the upside, advisers said.

If the final price of the lesser-performing commodity is greater than or equal to its barrier price, 70% of its initial price, the payout at maturity will be par plus 8.5%, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, investors will be fully exposed to the decline of the lesser-performing commodity from its initial price.

“If you don’t think we’ll have a dramatic pullback in oil in the next year, this is a very decent way to get a high-yielding security,” said Tom Balcom, founder of 1650 Wealth Management.

The oil underlier referred to in the prospectus consists of light sweet crude oil futures traded on the Nymex.

Barrier

Balcom sees more volatility in crude oil than in the price of copper.

“If I had to guess what would be the worst performer, in other words, what my exposure will be, I would say it’s probably oil. Oil shale production in the U.S. represents a potential for oversupply,” he said.

“Copper has been pretty stable. It jumped up after the elections but has been trading range bound this year.”

Balcom said the 70% barrier and the short tenor made for an attractive combination.

“The barrier is not bad. I think the odds of breaching in one year are pretty low.”

Even if the worst underlier finishes negative, investors will receive the digital amount as long as the price does not drop more than 30%.

“This 8.5% yield is pretty generous considering you can get it at such a low barrier,” he said.

Balcom said he saw two potential uses of the notes in a portfolio depending on his clients’ goals and current exposure.

Portfolio positioning

The first one would be as a fixed-income replacement.

“It would be under the heading of high-yield, not as core bond, obviously. These notes are risky in a bond portfolio. They belong to the high-yield category,” he said.

Alternatively investors already having commodity exposure to either crude oil or copper could use the notes as a hedge.

“You already have the exposure but you want some level of protection. That could be used as a commodity replacement.”

With interest rates still at historical lows, advisors’ challenge is to provide yield for their clients without adding too much risk, he said.

Compared to a high-yield bond, which is subject to interest rate risk, the notes offered an attractive alternative for yield-hungry investors.

“They’re trying to create yield, and this is a way to do it for clients. Is it risk-free? No. But you have a 30% protection. I think 8.5% should attract buyers especially when you can get it up to 30% down.”

Balcom said he would not invest in the notes himself.

“The only reason I wouldn’t use it is because I don’t have a view on oil and copper. But for someone who already has the exposure and wants to take chips off the table, I think it makes sense,” he said.

Stocks are better

Steven Jon Kaplan, founder and portfolio manager at TrueContrarian Investments, observed the price of those two underlying commodities was too bullish to find the notes attractive.

“I know you can get the 8.5% return even if oil or copper are down, but precisely, I see oil and copper up a year from now, not down. And they could be up a lot more than 8.5%,” he said.

As an investor in those sectors of the commodity market, he said he would prefer to invest in the stocks of the producing companies. For instance, he sees more value in the stocks of copper mining companies or oil and gas producers.

Too little upside

“This 8.5% cap is incredibly low,” he said in reference to the product’s structure.

“At least it protects you on the downside. But I don’t see myself having to use the protection. I’m much more interested in finding undervalued sectors if I am long.

“If you buy this for the protection, you can invest in bonds issued by copper or energy producers.

“They tended to yield 20% to 30% last year. Now it has come down. But if commodities go up, the bond will go up in price. You get capital appreciation.”

Companies issuing high-yielding bonds are naturally the ones in trouble.

“It’s based on fear. People worry that a company would go bankrupt. But if you do your research on those energy producers and understand why you’re getting that type of return, you’ll be better off than trying to take advantage of some mathematical, artificially stated yield,” he said.

Citigroup Global Markets Inc. is the underwriter.

Citigroup Inc. will be the guarantor.

The notes will settle on Friday.

The Cusip number is 17324CKK1.

© 2015 Prospect News.
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