Citi's trigger PLUS linked to iShares MSCI Emerging Markets score high on risk, return scales

By Emma Trincal

New York, Oct. 25 - Citigroup Inc.'s 0% trigger Performance Leveraged Upside Securities due Nov. 5, 2019 linked to the iShares MSCI Emerging Markets index fund, despite ranking high on the risk scale, give investors a high potential for above-average returns, said Suzi Hampson, structured products analyst at Future Value Consultants.

The payout at maturity will be par of $10 plus at least 109.25% of any gain in the fund, with the exact leverage factor to be determined at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the fund falls by up to 40% and will be fully exposed to losses from the initial level if it drops by more than 40%.

The notes fit into the "leveraged return" category in Future Value Consultants' methodology. The category enables the research firm to compare the product with products of the same structure type when assigning scores.

"This is a six-year product in this category, which is a little bit unusual because those types of notes tend to range between one and two years," Hampson said.

"This one is quite a bit longer. Obviously, investors have to be willing to accept the longer duration. At the same time, the longer tenor will bring some benefits in terms of returns even if it adds more risk."

The key metrics of risk, return and price are measured through various scores established by Future Value Consultants. The research methodology generates reports designed to assess the quality of a product compared to the rest of the market.

Riskmap

The riskmap is Future Value Consultants' measure on a scale of zero to 10 of the risk associated with a product with 10 as the highest level of risk possible. It consists of the sum of two risk components: market risk and credit risk.

The riskmap for the notes is 4.45 versus an average riskmap of 3.39 for similar products, according to Future Value Consultants' research report.

"We have a product that shows some more risk than the average of the same product type, and that is due to the combination of more market risk and more credit risk," she said.

"The higher credit risk is not exactly an indication of the issuer's credit. It has to do with the fact that you have six-year exposure to the fund versus one to two years in average. Each year will increase the credit risk, which will be reflected in the riskmap."

At 0.84, the product's credit riskmap is greater than the 0.66 average score for products of the same type.

The average credit riskmap for all products is 0.49, showing an even bigger gap with the product.

"The big difference here is also due to the longer duration since the average of all products includes a majority of very short-term reverse convertibles," she said.

The market risk associated with the notes is higher than average as well. The notes have a 3.61 market riskmap versus 2.72 for the average of the same product type.

"The high market risk is less intuitive given what looks like a relatively protective barrier. The fund can drop by up to 40% without causing the investor to lose any principal. In addition, we're dealing with a final, or European, barrier, which is always better than having a trigger that can be hit any time during the term of the notes," she said.

"The main market risk factor here is the underlying fund, which has an implied volatility of nearly 20%. That's more than 15.5% for the S&P.

"The higher volatility associated with emerging markets increases the chances of breaching the barrier. It's not so much the barrier level that counts but rather how easily it can be hit. The more volatile the underlying fund, the riskier the product.

"Also keep in mind that your losses will be substantial - at least 40% of principal if the fund drops below the 60% trigger at maturity. You can lose anywhere from 40% to your entire investment."

Return score

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets and high- and low-volatility environments. A risk-adjusted average return for each assumption set is then calculated. The return score is based on the best of the five scenarios. With this product, the best scenario is bullish.

"Just because the product shows a higher risk level doesn't necessarily mean that the return will be low. We're focusing on risk-adjusted return," she said.

"This product has a very high return potential. You can certainly outperform the fund, and you can also outperform similar products based on the high return score."

The return score for the notes is 8.72, a point higher than the average score for the product category.

"Given the high amount of risk, investors in the product can expect much higher returns than the average similar product. The high return score suggests that this is what they get. Such result is largely due to the uncapped return. In addition, the amount of time gives you a greater potential for growth, especially if you run the model and calculate the score under the bullish assumption," she said.

"There is also some leverage, although the multiple is quite limited. But combine this with the no-cap and the six-year term and you get a very high return score."

Price score

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The notes have a 7.14 price score, compared with an average price score of 7.84 for the product type.

"The assessment of the fees taken out suggests that the fees are more than average," she said.

"The price score is disappointing."

Overall score

The overall score is another Future Value Consultants rating. It reveals the firm's opinion on the quality of a deal. The score is simply the average of the price score and the return score.

"If the price score had been great, the product would have had an outstanding overall score. But it's not the case. We have a low price score, at least lower than the average of the same product type," she said.

"We end up with an overall score of 7.92, higher than the 7.77 average, but the difference is not very significant. You could say the overall score is pretty much average.

"That's because you combine a much higher return score with a pretty low price score.

"This is one of those cases where the overall score doesn't tell you much. You have to look at the return and the price separately and make your own decision."

The notes would appeal to investors seeking higher returns in this asset class with some downside protection, she said.

"Investors in the notes are interested in getting exposure to emerging markets through this particular fund. But they don't want to do it directly through the fund. They're looking for the protection level," she said.

"Another motivation could be the leverage, but the leverage is weak, and so this feature is not very enticing. It looks like it was introduced as a way to offset the loss of dividends. So the leverage, unlike the barrier, is not really a competitive advantage when you compare this product with a direct ETF investment.

"Most likely, we have an investor who is happy to lock away his money for six years and give up dividends in order to obtain the downside protection offered through the barrier. The downside protection element is what makes the product different and perhaps better for some than the underlying itself."

The notes (Cusip: 17321F763) are expected to price Oct. 31 and settle three business days later.

Citigroup Global Markets Inc. will be the underwriter.

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