Citi’s $3.2 million dual directional digital plus on indexes, ETF offer equity substitute

By Emma Trincal

New York, Sept. 13 – Citigroup Global Markets Holdings Inc.’s $3.2 million of 0% dual directional barrier digital plus securities due Sept. 11, 2026 linked to the Russell 2000 index, the S&P 500 index and the iShares MSCI EAFE ETF give investors an alternative to a long position in a diversified portfolio, advisers said.

If the worst performing underlier finishes at or above its initial level, the payout at maturity will be par plus the greater of the digital return of 53% and the return of the least performing underlier, according to a 424B2 filing with the Securities and Exchange Commission.

If the worst performing underlier falls by up to 30%, the payout will be par plus the absolute value of the return of the worst performer.

Otherwise, investors will lose 1% for every 1% decline of the worst performer from its initial level.

“While I don’t like worst of, these are three asset classes that you’re going to have in your portfolio anyway,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

Core allocation

“You’re always going to have blue chips, almost always going to have small-cap and should have exposure to developed markets.”

In a traditional portfolio, the three underliers would represent a diversified mix of assets.

“You want asset classes that are not correlated to the U.S. You also want diversification between large-cap and small-cap. That’s if you have a diversified portfolio. However, in a worst-of like this one, it’s a little bit different.”

“The non-correlation brings out additional risk. But you get compensated for it,” he said.

The five-year tenor was “a little bit longer” than desirable, he said.

“But if you’re going to be fully invested, it doesn’t matter if it’s a three or a five year because you already own those three indices. So, it’s not an issue for me even though it’s a little bit long,” he said.

Downside

When assessing a note, Kunhardt said he always looks at the downside first. In this case the combination of a barrier and absolute return was attractive.

“I have a 30% barrier. What’s the alternative? The alternative is to be long the index. I’m better off with the 30% protection. So that’s a plus,” he said.

“As long as I don’t breach, I’m good to go.

“Besides, even if I breach, I’m no worse off than being long the index.

“And then there is the absolute return. If I’m down 25%, I just made 25%. That’s another plus.”

Worst-of

The exposure to the worst performing asset however represents an additional risk, which investors should take into consideration, he noted.

“The only potential hiccup is the worst-of,” he said.

“I’m not betting on one asset class but on three different ones. And if only one blows up, the whole thing can fall apart.

“It’s an alternative to being long the three asset classes. If I’m fully invested, I have exposure to those three anyway. “But ultimately the outcome is different since I have exposure to the worst of.”

Investors however get compensated for the risk of diverging performances between the underliers.

The barrier and the absolute return are one aspect of the tradeoff. The other one is on the upside, he noted.

Return expectations

“On the upside, everything depends on your market outlook,” he said.

“You’re getting at least 53%, which is shy of 10% a year. We expect equity returns to be materially lower. So, for us it’s a plus,” he said.

Kunhardt said he has a conservative outlook on future equity returns. His firm follows the return simulations of consulting firm Mercer.

“We use their 20-year projections when we build our asset allocations for our clients,” he said.

“Going out 20 years, they don’t project returns exceeding 6.8% on an annual basis.

“That makes the 53% digital return pretty appealing. Above that, you’re long the index. There’s no cap.

“I like this note. It’s a good alternative to a long position, and one that gives you some downside protection.”

Pricey U.S. stocks

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, also liked the digital payout.

“It’s interesting. You’re getting a 53% minimum gain on the upside as long as the index is not negative. That’s reasonable,” he said.

“The barrier should be fine providing that we don’t run into a big sell-off or recession.”

Regarding the likely worst-of underlier, Chisholm said he sees more risk in domestic equity.

“Personally, I think the U.S. markets are more likely to be in trouble. International assets will do better because they’re not as overvalued.”

“But everybody has exposure to both the U.S. and the non-U.S. developed markets.”

“So, you’re looking at money you’re already going to be invested in anyway,” he said.

Recession risk

The real risk associated with the notes is a potential severe bear market.

Chisholm does not exclude a negative scenario within the next five years. If the market and the economy go into a severe recession, the note may not be “recession-proof,” he said.

“By recession, I mean a much more severe sell-off than March of 2020,” he said.

“What I have in mind is something like 2000 or 2008. These were real recessions. The economic cycle was changing. The market cycle was changing. Japan had a 30-year recession for instance. I’m not referring to last year. Last year was volatility,” he said.

“If we had a big recession, I’m not sure the note could sustain the sell-off.

“On the other hand, if things stagnate for years like in Europe, then yes it’s appealing.

“As long as we don’t have a major crisis, it’s a reasonable note.”

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes (Cusip: 17329QB90) settled on Friday.

The fee is 0%.

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