Citigroup's digital notes linked to Dow Jones Real Estate ETF offer good value for sector bet

By Emma Trincal

New York April 25 - For investors looking for direct exposure to the real estate equity sector, Citigroup Inc.'s 0% jump securities due May 5, 2015 linked to the iShares Dow Jones U.S. Real Estate index fund offer good value and attractive return potential in a simple, easy-to-understand structure, said structured products analyst Suzi Hampson at Future Value Consultants.

If the final share price is greater than or equal to the initial share price, the payout at maturity will be par plus a fixed return of 21.5% to 24.5%, or $2.15 to $2.45 per $10.00 note, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will be fully exposed to losses.

"This is for investors looking for a particular sector play, specifically real estate stocks and REITS," she said.

"They want the exposure to a particular industry, and that's the first requirement they may have. They then have the choice: They can either invest directly into the fund or use this product to get a different payoff.

"If the fund after two years has a performance of less than the 24.5% cap, this product will outperform because investors get that fixed return, the digital payout. Right there, you have a form of return enhancement. It's only if the fund grows more than the cap that the product would underperform not including the dividends though, and obviously the dividends are significant and should be taken into account."

The dividend yield on the iShares Dow Jones U.S. Real Estate index fund is 3.4%.

"The strategy is whether you want to be bullish on the index or take the fixed digital. For investors who are not strongly bullish but still expect growth in the sector, the lack of any downside protection allows you to afford quite a high payment level," she said.

"This would work for moderately bullish investors but not for the strongly bullish investors who see even more upside in the fund, above the cap."

The iShares Dow Jones U.S. Real Estate index fund is already up 12% for the year. Over the past year, the fund gained 13.5%. It is up 16% from two years ago.

Simplicity

Another appealing aspect of the product is its simplicity, she said.

"Investors and advisers often look for products that are easy to explain and easy to understand. This is definitely one of those. The digital payment on the upside is easy to comprehend. The downside even is more straightforward to explain than many other products, such as autocallables or trigger notes, since there is no protection, no barriers to observe at the end or during the term. You're going to get the level of the fund," she said.

"If you think of the simplicity side of it and if you compare this with digital products offering a barrier or a buffer, those may offer you more protection, but they're hard for the financial adviser to evaluate. It's difficult to measure the costs of that protection and how much it's really worth. You do not have such problem with this one. If you had a barrier, you would be losing some of the upside. With this one, it's easier to explain the structure. It's easier for the investor to understand the terms.

"Overall, the payoff represents a pretty straightforward trade-off that can be easily explained. You're getting the potential bump up in return with the digital payoff, but you're not going to get paid the dividends.

"People who invest in structured products are already familiar with the idea. They know they're going to give up dividends. There isn't really much we can do about it."

The notes fit into the digital product category in Future Value Consultants' methodology. These notes typically pay a fixed return if the final level of the underlying is above a certain level, which in this case is the initial price, she explained.

Risk

Future Value Consultants rates the risk associated with a product on a scale of zero to 10 with its riskmap. The higher the riskmap, the higher the risk of the product. The riskmap is the sum of two risk components: market risk and credit risk.

The market riskmap of 2.89 is slightly more than the 2.72 average market riskmap seen with similar structures, Hampson noted.

"There is not much difference. It's a little bit higher perhaps because there is no downside protection - barrier or buffer - at all. That's probably why," she said.

The 0.70 credit risk is "average", she said.

"It's less than the same product type average of 0.82 but higher than the 0.56 average credit risk of all products.

"Overall, the riskmap of 3.59 is just about average when you compare this product to its peers."

The average riskmap for digital notes rated by Future Value Consultants is 3.54.

When compared to all products - the majority of which being reverse convertibles - the notes' market riskmap of 2.89 turns out to be less than the 3.42 average score for all securities rated by Future Value Consultants. The "all products" group has a risk level skewed by the high proportion of reverse convertibles linked to single stocks, she said.

"This is probably why you have this riskmap difference when it comes to market risk."

Return, price

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.

The product has a return score of 7.73, while its peers score 7.32 on that scale.

"The return score is a bit higher than the average for similar products," she said. "We're looking at the bull market scenario as the best assumption. This is probably because the digital payment amount gives you a higher return if the index performs below the cap. Given the amount of risk associated with the product, your potential return is higher than average, and that's what the score suggests."

The return score is also much higher than all products.

When a financial adviser is in the process of selecting a product that gives a specific exposure to an asset class or sector, presumably the first step is to find a payoff that is a good fit for the client's attitude towards risk and for the overall portfolio. Then, the adviser may look at the various scores. But it would be a mistake to look at the scores first without having a clear plan for the portfolio. The adviser should have an investment strategy in place before comparing the products.

Future Value Consultants measures a note's value to the investor on a scale of zero to 10 via its price score. 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 show an 8.73 price score, which is "much better" than the average digital product with a 7 price score.

"This shows that the issuer spent a decent amount of money to buy the options for the different components of the product, which would indicate that it took less in fees. Investors get some good value for their money," she said.

Future Value Consultants, with its overall score, offers its opinion on the quality of a deal. The score is simply the average of the price score and the return score.

The notes have an 8.23 overall score, compared with 7.16 for similar products. The difference is even greater when the score is compared with all products, which as a group show an average overall score of 6.64.

"We have a very high overall score, which shows one point above the average for digitals. That's because we already have a high return score, and the price score is even better in comparison to similar products," she said.

"The score is quite convincing if you're already considering this asset class. It suggests good value for your money and a good potential return.

"You have the potential to outperform the index with a capped return, but you're giving up dividends and you're taking on credit risk.

"As far as introducing people to structured products, it's probably best to start simple. This has a quite straightforward payoff, and it's a decent investment if you expect small to moderate growth."

The notes (Cusip: 1730T0SU4) are expected to price on Tuesday and settle three business days later.

Citigroup Global Markets Inc. will be the agent.

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