RBC’s leveraged return notes tied to Euro Stoxx 50, FTSE 100 offer deep barrier, European play

By Emma Trincal

New York, July 18 – Royal Bank of Canada’s 0% barrier enhanced return notes due July 22, 2021 linked to an equally weighted basket of the Euro Stoxx 50 index and the FTSE 100 index offer eye-catching terms for long-term investors seeking full exposure to European markets, buysiders said.

If the basket return is positive, the payout at maturity will be par plus 150% of the basket return, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the basket falls by up to 58% and will be fully exposed to the basket’s decline if it falls by more than 58%.

Euro bet

The Euro Stoxx 50 index is a euro zone benchmark, and the FTSE 100 index tracks the return of the 100 largest U.K. companies. As a result, the notes give equal exposure to both markets, noted Scott Cramer, president of Cramer & Rauchegger, Inc.

“For somebody who is modestly bullish for where these two are going to be five years from now, this is a great bet,” he said.

“It doesn’t have to go up as much as the markets to get a reasonable return, but you have to believe that, five years from now, point to point, your stocks will be higher.”

Deep barrier

The protection is an important feature of the notes.

Truly bullish investors would probably choose more leverage and less protection, he said.

“With this note, you’re trying to capture more upside and protect the downside at the same time,” he said.

“If you like Europe and want the exposure, this is a good way to play it.”

Getting up to 58% of contingent protection is highly unusual, he noted, even with a longer-dated note.

“Maybe with what’s going on with Brexit, they’ve been able to get some good levels of volatility and they were able to take advantage of the options,” he said.

“For somebody who is willing to hold the notes for five years, this is definitely a very well-protected product.”

Tenor

Michael Kalscheur, financial adviser at Castle Wealth Advisors, who likes longer-dated notes for his clients, was very impressed with the structure.

“I’m hard-pressed to find anything wrong with this particular offering,” he said.

Credit risk exposure can be an issue with long tenors, but RBC offers a high credit rating, he noted.

When comfortable with the credit of an issuer, Kalscheur said he prefers five-year structured notes rather than shorter products because he wants to “encourage” his clients to be “buy-and-hold” investors.

“It’s our wheelhouse,” he said about the five-year tenor he favors.

The underlying indexes are not as well-known as the S&P 500 index or the Dow Jones industrial average. But investors who may not be familiar with the FTSE 100 or the Euro Stoxx 50 will at least recognize some of their big holdings.

“Who has never heard of Unilever?” he said.

“These are pretty big multinationals. A client is not going to be put off by this.”

Strong protection

When evaluating the strength of a barrier, Kalscheur likes to run historical performance to see how often statistically an index will drop below a certain threshold during a given trailing period. Most of his historical computations are based on U.S. indexes. He has no information on the FTSE 100 but has data that goes back to 1986 for the Euro Stoxx 50.

“There hasn’t been in the past 30 years one time when this particular index has been down 58% in a five-year period,” he said.

“Maybe the risk is attached to the FTSE, but there is this immense protection on the downside.

“It gives me a heck of a lot of confidence to know that even in the past 30 years, this type of decline has never happened.

“If it was a worst of, it would be entirely different. But you have a 50/50 mix that further diversifies your underlying basket.

“In other words, I’m not concerned with breaching the barrier on this one.”

Upside, fees

The leveraged upside without a cap is a positive part as well.

“One hundred and fifty percent on the upside uncapped, that’s fantastic,” he said.

“Anytime you can get leverage plus no cap on top of it, it’s real great.

“You can outperform the benchmarks by a third. If the indexes are up 10%, you get 15%. That’s a 50% bonus.”

Finally, the 3.25% fee, or 65 basis points per annum, is in the range of what this adviser is looking for.

“That’s the institutional type of pricing we like to see.”

Kalscheur said he was wondering how the issuer was able to offer “such good terms,” adding that Brexit may have created enough uncertainty and volatility to optimize pricing.

The event itself was not a concern in his view.

“I don’t think we’re going to get another Brexit in the next five years,” he said.

“We like the maturity, we like the credit, we love the type of fees, the leverage, the uncapped, the barrier. This is a rock-solid structure.

“It hits every category we look for in a structured product.”

RBC Capital Markets, LLC is the underwriter.

The notes will price July 18.

The Cusip number is 78012KRB5.

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