JPMorgan’s review notes tied to Euro Stoxx 50, FTSE 100 seen as bet on political risks

By Emma Trincal

New York, Feb. 28 – JPMorgan Chase Financial Co. LLC’s 0% review notes due March 5, 2020 linked to the lesser performing of the FTSE 100 index and the Euro Stoxx 50 index give investors an above-market return based on the correlation between the U.K, which is leaving the European Union, and the euro zone. The bet offers a strong protection and return potential, but advisers said risks, especially political ones, were too many.

The notes will be guaranteed by JPMorgan Chase & Co., according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus a call premium if each index closes at or above its initial level on any annual call date. The call premium is expected to be at least 9.25% per year and will be set at pricing.

If the notes are not called and the final level of each index is greater than or equal to its trigger value, 50% of its initial level, the payout will be par. Otherwise, investors will lose 1% for each 1% that the lesser-performing index finishes below its initial level.

The FTSE 100 index tracks the performance of the U.K. The Euro Stoxx 50 index is the benchmark for the euro zone.

Correlation

“The bet is the dispersion of the two. The investor will be better off if the Euro Stoxx and the FTSE are more tightly correlated,” said Jonathan Tiemann, founder of Tiemann Investment Advisors.

The coefficient of correlation is currently high at 0.92.

“If they stay tightly correlated, this worst-of is more like a normal type of deal over one index and in that case, 9% a year seems pretty generous.

“If they become negatively correlated, if one goes up and the other goes down... then you run the risk of not getting paid,” he said.

Market risk

Investors had very little exposure to market risk, he said.

“You really need the market to crash to lose principal, so that wouldn’t be my main concern, although you still have that residual risk, at least in theory.”

Investors however should be paying attention to the “opportunity risk,” which he defined as being invested for three years without pocketing any premium.

“It takes both of the indices to be positive in order to get paid. If investors are keen to have income, they may have to wait for three years...they may not even have anything in three years. It’s kind of odd.”

Memory

One positive item in the structure was the so-called memory coupon. If an investor misses a call, he gets paid on the previous missed payment. As such a noteholder could receive 18.50% if called on the second year and 27.75% three days prior to maturity on the final review date, according to the prospectus.

But the memory feature, while “attractive,” was not enough to make the note suitable for income.

“I don’t see it as a good fixed-income replacement because you don’t know for how long you’re going to get a coupon. You don’t even know if you’re going to get one,” he said. “Are you going to receive 9.25% a year for year one, or 18% for year too, or zero?”

Headlines

More concerning was the risks of seeing the two indexes diverge in direction in the course of the three years.

Several political events are set to take place this year in Europe, such as the Dutch elections in March followed by the French elections in April. In both countries a leading far-right candidate is overtly opposed to remaining in the European Union, which could destabilize the euro and precipitate a market correction.

“There is a possibility to see Europe and the U.K. diverge more than they have, and that would work against the investor,” he said.

Finally the “moving pieces” of the product was also an issue.

“This has so much complexity to it, you wonder why you would show it to begin with,” he said.

“I guess if your goal is to wave that 9.25% in front of your client, it may achieve that.”

Politics

The choice of the two underlying assets was not coincidental, said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

“There are some known events coming up. That’s the reason this note exists I suppose,” he said.

While the U.K. is preparing for the implementation of its exit from the European Union, some European countries will see political changes, he noted. Aside from France and the Netherlands, Germany will also hold elections later this year. Italy will follow next year and Greece in 2019.

“This note is some sort of political bet around the future of the European Union and how the Brexit process unfolds,” he said.

“But it’s impossible to predict those outcomes and how those two markets will react in relation to each other with all the political agendas that are in play,” he said.

Barrier, call

The barrier at maturity was attractive, he conceded, agreeing with Tiemann.

“It’s hard to imagine that either market would go down 50%,” he said.

The “reasonable probability” of not getting paid was the main concern.

If the notes failed to be called on the final call date and if one of the two indexes finished negative, even by a fraction of a percent, investors would have been “sitting for three years, getting nothing,” he said.

Finally the choice of the two underlying indexes increased the risk associated with the worst-of payout.

Peculiar view

“I’m not particularly impressed by the notes because of the arbitrages that are going on between those two markets based on political events,” he said.

“There are other ways to speculate on the outcome of Brexit or the future elections to be held in some European countries.

“The rise of populism is a trend to be reckoned with, here and in Europe, pretty much everywhere.

“Since it’s a worst of the two indices, something could easily go wrong.

“Effectively what you’re betting on with this note is that there won’t be any instability in Europe. If that’s your belief, then this note makes sense.

“But I don’t think it’s the most rational bet to make right now.

“Most people predict some instability in Europe in the next three years given what’s happening in the world.

“I would not be interested in taking the opposite side of that bet.”

J.P. Morgan Securities LLC is the agent.

The notes will price on Wednesday.

The Cusip number is 46646QLQ6.

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