JPMorgan’s leveraged notes tied to index basket designed to hedge U.S. persistent equity rally

By Emma Trincal

New York, Feb. 25 – JPMorgan Chase & Co.’s 0% capped enhanced participation notes due April 6, 2017 linked to a basket of international equity indexes is designed to tap into markets that offer lower valuations than U.S. equity benchmarks while protecting investors against the risk of a potential correction amid a long-lasting U.S. bull market, sources said.

The basket is comprised of the Euro Stoxx 50 index with a 37% weight, the FTSE 100 index with a 23% weight, the Topix index with a 23% weight, the Swiss Market index with a 9% weight and the S&P/ASX 200 index with an 8% weight, according to a 424B2 filing with the Securities and Exchange Commission.

If the final basket level is greater than the initial level, the payout at maturity will be par plus 300% of the basket return, subject to a 30% to 35.25% cap. The exact participation rate will be set at pricing.

Investors will be fully exposed to any decline in the basket.

Inflows and outflows

“We’re seeing billions flowing into the European market and simultaneously U.S. equity funds are showing net outflows,” a market participant said.

“The U.S. stock market since QE has more than doubled. People are starting to be a little bit cautious.”

The Federal Reserve Bank began to buy mortgage-backed securities by the end of November 2008, initiating its first round of quantitative easing, or “QE.”

During the same time, however, the Euro Stoxx 50 showed a lower performance, up less than 30%.

“European stocks have underperformed the S&P for a while. But we’re starting to see the reverse trend. Since the beginning of the year, euro zone stocks have moved up 6.5% while the S&P is only up 2.5%.

“There’s a reverse trend happening right now in terms of flows. That’s what hedge funds are doing actually. They’re buying Europe and selling the U.S. You don’t actually need to sell the U.S. yet. But Europe will do well.”

Return enhancement

Investors in the notes are mildly bullish on the foreign equity markets represented in the index, which are the euro zone, the U.K, Japan, Switzerland and Canada.

The sentiment is bullish since the structure offers no downside protection. But the view is moderately bullish: less than 5% in annualized growth in the basket would be enough to enable investors to hit the 30% cap level, assuming the issuer prices the deal at the lower end of the range.

The annualized maximum return would be 14% with compounding based on this assumption.

“It’s capped without protection because of the leverage. It’s a three-to-one leverage. You have to pay for that,” said the market participant.

“If the basket does less than 30% in two years, you get to outperform.”

U.S. bulls

Some investors were not convinced that it’s a good time to retreat from the U.S. bull market.

“The Dow broke all-time highs again. The U.S. market is doing well. The only concern for the U.S. is the dollar. If it continues to be stronger, it will create some headwinds,” a financial adviser said.

“I don’t have many clients who want to diversify away from the U.S. right now, and I’m not sure why they should.

“Japan is a mess. It’s been a mess for 20 years. Europe is not in great shape. Greece has a problem... Spain and France have problems with debt issues. I’ve moved much more money into U.S. equity even if the dollar is an issue.

“And I continue to think the U.S. economy is stronger than anywhere else in the world.

“I guess perhaps investors in this note are using it to hedge their existing U.S. portfolio.”

The same basket with the same weightings has been used more than 20 times since mid-January by a variety of issuers.

A landmark deal priced on Jan. 30 when Barclays Bank plc brought to market $547.56 million of 0% capped return enhanced notes due Feb. 18, 2016 tied to this specific basket. It was one of the top 10 structured notes deals excluding ETNs and plain-vanilla lightly structured fixed-income products, according to data compiled by Prospect News. JPMorgan was the placement agent.

The recently announced notes (Cusip: 48125UFB3) will price on Friday and settle March 6.

J.P. Morgan Securities LLC is the agent.

© 2015 Prospect News.
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