RBC’s $27.03 million Accelerated Return Notes on technology stocks offer ‘FANG’ access

By Emma Trincal

New York, Sept. 5 – Royal Bank of Canada’s $27.03 million of 0% Accelerated Return Notes due Oct. 25, 2019 linked to an equally-weighted basket constituted by the four so-called “FANG” stocks caught the market’s attention for the use of the most popular tech stocks put together in one basket.

The basket is comprised of the common stocks of each of Facebook, Inc., Amazon.com, Inc., Netflix, Inc. and Google’s parent company Alphabet Inc.

Together those four stocks are commonly referred to the “FANG,” an acronym made of their initials.

The payout at maturity will be par of $10 plus 300% of any basket gain, up to a maximum return of par plus 19.5%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will be exposed to any losses.

FANG in a basket

“This is interesting. We rarely see equally-weighted FANG baskets. Most of the time, they’re used in worst of for income enhancement,” said Matt Rosenberg, sales trader at Halo Investing.

“I’m surprised that there is no downside protection since tech stocks had a tremendous summer.”

Amazon last month was up 13.3% and Netflix jumped nearly 10%.

Facebook’s performance was flat due to a 19% one-day drop in its share price at the end of July in post-earnings reaction.

Alphabet traded sideways last month as well.

Apple, Inc., which is not included in the basket but could be under the acronym “FAANG” used to add Apple to the FANG strategy, jumped 20% in August alone.

Hot and volatile

The $27 million bid suggested investors must have found the deal appealing despite the one-to-one downside exposure, said Rosenberg.

“Many people have reasons to be bullish on these names,” he said.

“The FANG story is compelling not just because it’s a key holding in ETF portfolios and in most allocations in general.

“It’s also because many investors have the conviction that tech is going to continue to lead the market up.”

Yet the sector experienced volatility this summer.

Names such as Facebook, Twitter, Inc. and Netflix recorded sharp losses toward the second half of July.

Facebook for instance is down 15.5% over the past three months.

“As a result of more volatility, some FANGs could trade sideways,” he said.

Easy cap

The leveraged structure employed in the product could be helpful in such scenario.

The 19.5% cap with three-times leverage generates a 16.5% annualized compounded return. It only takes a 5.5% annual positive return to achieve the maximum gain as a result of the high gearing.

“But I think that there are also mixed feelings about tech,” said Rosenberg.

“Nasdaq is on such an epic run. As far as privacy issues and talk of regulation, there is a lot of uncertainty,” he said.

He made his comment as Facebook and Twitter executives appeared before the Senate Select Committee on Intelligence about social media companies and foreign influence in the United States. on Wednesday. Alphabet, which was expected to be present, skipped the hearing.

Diversification

The basket itself however provides some level of safety. Diversification across four different stocks is one way to achieve it, he said.

“I like the equal-weighting for a note without protection. It allows you not to carry the tail risk that we’ve seen in the tech sector,” said Rosenberg.

He offered an example: one of the three basket components could rise by 50% while the three others combined would be down 40%.

“Net-net you’re still up 10% and you’re still going to cap out at 19.5%.”

Asymmetrical leverage

A market participant said the structure was interesting for its short maturity, high leverage and cap as well as the one-to-one downside exposure not subject to any leverage.

“You’re getting a lot of leverage on the upside with a pretty good cap. Of course you won’t have protection and you have to use risky stocks otherwise there’s no way to make the structure work over 14 months,” he said.

The use of a plain-vanilla leveraged product must have been appealing to investors who usually get exposure to the FANG stocks via worst of, he added.

“It’s hard to explain a customer any type of worst of. They’re like: how come I’m getting the worst of?” he said.

He wasn’t sure about the timing of the trade as FANG stocks are trading at rich levels.

One risk-mitigation factor was the fact that highly leveraged notes such as this one do not apply any leverage on the downside.

“One-to-one on the down, three-times up...You have an asymmetrical risk that works to your advantage. It’s the reason they price it with no downside protection. This is a bullish structure that fits within the Merrill franchise.”

BofA Merrill Lynch is the underwriter.

The notes (Cusip: 78014F627) priced on Aug. 30 and will settle on Friday.

The fee is 2%.

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