Citigroup’s buffered notes linked to MSCI EAFE offer potential alternative to long position

By Emma Trincal

New York, Feb. 25 – Citigroup Inc.’s 0% 25- to 28-month buffered notes linked to the MSCI EAFE index show an attractive structure for investors seeking exposure to the equity markets of developed countries with a potential to outperform the index, buysiders said.

The payout at maturity will be par plus 160% of any index gain, up to a maximum settlement amount of $1,336.00 to $1,395.20 for each $1,000 stated principal amount, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 15% and will lose 1.1765% for every 1% decline beyond 15%.

Solid terms

“From a deal standpoint it looks like a good prospect. Whether you want to invest in this index or not is a different question,” said Scott Cramer, president of Cramer & Rauchegger, Inc.

Both the amount of upside leverage and the 15% buffer on the downside should appeal to investors seeking exposure to this index.

The protection is also appealing despite the leverage.

“It’s almost one-to-one on the downside with a 1.17 times. So you have a 15% buffer, which is good enough,” he said.

Lagging the United States

The MSCI EAFE index tracks the stock performance of developed countries except the United States and Canada. More than 60% of the index is comprised of stocks of European companies. Japan is the country with the largest allocation with a 23% weighting.

The index so far this year has dropped 8%, underperforming the S&P 500 index by six percentage points.

“Clearly one of the reasons you can get those terms is because many people are bearish on the EAFE and so the options are cheap,” he said.

“If you expect growth in this market over the next two years or so, then definitely this is a good play with some downside protection.”

Alternative to equity

He compared the notes with a direct investment in the index.

“If you buy the fund, you’re going to have expense fees, you’re not going to get 1.6 leverage and you won’t get the buffer,” he noted.

“But you’ll also have 100% liquidity at any time.

“If you do portfolio construction, if you have a fundamental approach as opposed to being a trader who would be in and out of the position, it makes sense to use the notes.”

The important choice for investors is to decide whether the underlying investment theme is a good bet.

“You can’t be worried about the risk that something catastrophic would happen. If you’re wrong, you can’t trade out of it,” he said.

“Of all the things that make up the EAFE, there is the perception that many countries in the index, in particular European countries, are not having growth.

“If I’m bearish, you can’t give me enough leverage and buffer to get in.

“Now if you’re confident that it’s the right market, if you want to push forward in there, it’s a great way to be in.”

Growth potential

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he is bullish on the index but moderately so. As a result the leveraged and capped structure are attractive to him.

“I like the asset class. Over the next two years, we’re likely to see headwinds as far as getting a good foundation for growth, especially with European countries and Japan,” he said.

“At the same time, these regions have shown their interest to pursue accommodative policies as a growth strategy.

“I am bullish for that timeframe even if my return expectation for this index remains modest.

“So the leverage should enhance returns, and the cap in my view is sufficient.”

Headwinds

Depending on the exact maturity and cap terms, which will be set at pricing, investors may expect to get a maximum return of about 15% to 19% a year.

“I don’t think you’re going to exceed the cap on the upside,” he said.

In terms of risk control, the entry point is enticing when combined with the buffer.

“In the past year, the EAFE index has been down in the mid-teens. The buffer in that case is enough to mitigate the downside.

“Areas like Europe and Japan have some very interesting potential in the near future. However, because of some headwinds that will have to be dealt with, I like the idea of having an asset class like this inside a structured note.

“If was making an allocation to Europe, I would prefer to buy the notes rather than being long the index directly.”

Citigroup Global Markets Inc. is the agent.

The notes will price on Friday.

The Cusip number is 17298CA99.

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