Citigroup's buffered notes linked to S&P 500, two ETFs show fair buffer, payout for mild bulls

By Emma Trincal

New York, Dec. 9 - Citigroup Inc.'s 0% buffer securities due Dec. 13, 2018 linked to an equity basket should appeal to cautiously bullish investors who seek to ride out a potential market correction with a diversified equity exposure and some downside protection, according to financial advisers.

They said that the large buffer offsets the disadvantage of the upside cap as long as the noteholder is not too bullish.

The basket is a mix with more than half in U.S. stocks and the rest in international equity. It is comprised of the S&P 500 index with a 60% weight, the iShares MSCI EAFE index fund with a 25% weight and the iShares MSCI Emerging Markets index fund with a 15% weight, according to a 424B2 filing with the Securities and Exchange Commission.

The upside is not leveraged and is capped at 46%, giving investors a one-for-one exposure to the basket up to the maximum return.

On the downside, however, the notes offer a 30% buffer: Investors will receive par if the basket declines by 30% or less and will lose 1% for every 1% that it declines beyond 30%.

Fair trade-off

"This is a fair trade-off, especially for someone who thinks the stock market may struggle over the next five years," said Scott Cramer, president of Cramer & Rauchegger, Inc.

"Five years is a good timeframe. It's a point to point. Clearly, the risks are some macro-economic events or something happening near the end. But the 30% buffer is generous.

"The 46% cap, while not a really high cap is definitely generous. It's about 9.5% a year."

Another advantage of the product, in his view, is the access to a diversified portfolio of equity.

The S&P 500 with its 60% weighting represents the U.S. large-cap sector, and investors also gain exposure to developed markets, excluding the United States and Canada, via the EAFE index fund as well as to emerging markets through the emerging markets fund, he noted. The basket, he said, makes for a fairly balanced mix of U.S. and non-U.S. stocks in various regions of the world and diverse stages of development.

"The weighting is a fair weighting. Each of these indexes are diversified in their own worlds. It's a fair mix of equities. Plus you have this principal guaranteed of 30%," he said.

Investors in the notes would have to be willing to limit the upside for more downside protection.

"Yes, there's the cap. But I don't think it's ever fair comparing a payout like this one, comprising a cap and a buffer, with a pure long-only position. This note gives you the downside protection which you wouldn't get if you invested in the basket directly.

"That's the trade-off, and you pay for that with a cap. You also give up liquidity. These are facts."

For people concerned about giving away too much of the potential return, Cramer said that the notes were never designed to represent a large chunk of a portfolio.

"Nobody should ever use those notes as 100% of their portfolios. Using a little bit of it makes sense if you're bullish but at the same time fearful that something bad may be happening. You're giving up some upside, but the only upside you're giving up is above 9.5% a year, which is not bad. And you get some very generous protection."

Carl Kunhardt, wealth adviser at Quest Capital Management, agrees that remaining invested in a diversified equity portfolio while hedging some of the correction risk is what makes the notes particularly appealing.

"I like it. It's an index portfolio with a nice mix of diversified equity investments," he said.

"The 30% gives you reasonable downside protection. If you want more and you're bearish, you wouldn't go there anyway.

Moderately bullish

With the S&P 500 having more than doubled over the past five years and up 27% just for this year alone, a lot of market participants are predicting a correction. Even without a strong correction, no one predicts that the market will continue to hit new highs week after week for an extended period of time, he said.

"If you're mildly bullish, it's very nice," Kunhardt said.

"You may be concerned about an upcoming correction after the rally that we've had over the past few years. But a correction is not going to last five years.

"This note gives you a chance to stay invested with a global diversified exposure to equity."

Any investor who believes that the bull market is far from over would not be investing in the notes given the cap, he said. In fact, investors should be prepared to deal with the upside risk.

"You're obviously going to hit the cap. These indexes have exceeded 9.5% a year over the last five years," he noted.

"If you have a strong bullish outlook, this note is not the right investment for you.

"But if you're mildly bullish, the market could easily go through a correction in the middle of the period and you would have exposure during the rest of the term with the protection."

Hedge

Kunhardt said that the notes should be carefully allocated to the right part of the portfolio.

"I am cautiously optimistic, and I can see myself using it in two different ways," he said.

"I could invest in it as a conservative portion of my equity allocation.

"Alternatively, I could use it as a hedge in an aggressive portfolio, the way you would sell covered calls. I wouldn't use it as a return enhancer, that's all."

Citigroup Global Markets Inc. is the underwriter.

The notes are expected to price Dec. 10.

The Cusip number is 1730T0E93.

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