Deutsche Bank notes adjust for inflation; structure addresses common investor concern, adviser says

By Kenneth Lim

Boston, Jan. 26 - Deutsche Bank AG's planned barrier rebate notes that adjust for inflation give investors an opportunity to seek a real return on their investment, an investment adviser said.

"These are like structured notes with TIPS [Treasury Inflation Protected Securities]," the adviser said.

Deutsche Bank, through its London Branch, plans to price zero-coupon CPI-indexed buffered barrier rebate notes due Feb. 4, 2011 linked to the S&P 500 index.

If the S&P 500 never closes above 155% of its initial level during the life of the notes, at maturity investors will receive par plus 112% to 133% of any index gain plus the change in the Consumer Price Index. The payout will be par plus the inflation adjustment if the index does not decline by more than 25%. Investors will lose 1% for every 1% that the index declines beyond the sum of 25% and the inflation adjustment.

The exact participation rate will be set at pricing.

If the S&P 500 closes above 155% of its initial level during the life of the notes, at maturity investors will receive 120% of par plus the inflation adjustment provided the index ends at 75% of its initial level or higher. Investors will lose 1% for every 1% that the index declines beyond the sum of 45% and the inflation adjustment.

Unusual structure

Inflation adjustment in non-CPI linked products is rare in structured products, the adviser said.

"I'm not sure why," the adviser said. "I haven't seen anything like this."

The adviser compared the product to structured notes where the basic note structure is based on TIPS, which adjust the principal based on changes in the CPI.

"It's basically a typical structured product, but whenever you get your payout they add in the inflation rate," the adviser said.

Adding inflation to the formula could be attractive for investors, the adviser said. Inflation is an especially significant concern for longer term investors because positive inflation will eat away at returns, the adviser said.

"We're always trying to beat inflation," the adviser said. "If you don't at least match the rate of inflation, you're basically getting poorer because the purchasing power of your investments will go down."

Cautious enthusiasm

But the adviser also urged careful consideration in deciding whether the product is suitable. First of all, the inflation adjustment is a nice feature to have, but it is independent of the principal strategy of the notes, the adviser said.

"Yes, you get inflation adjustment, which is nice, but that's meaningless if you don't think the basic underlying strategy makes sense in the first place," the adviser said. "If you think the strategy on the S&P 500 makes sense, then you might compare this to other products that offer a similar strategy and see if the inflation adjustment is worth the price."

The product could also work against investors in a deflationary environment, the adviser said.

"People are actually worried about deflation now, and if there's deflation then your returns will actually be lowered by the feature," the adviser said.

Beyond the inflation adjustment feature, the product has a fairly complex payout structure, the adviser said.

"This can be really complicated to explain to someone," the adviser said. "There are like six different ways to calculate your return on this one product alone, and so many different variables."

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