RBS' digital buffered notes linked to the Dow are designed for all bulls, but tenor adds risk

By Emma Trincal

New York, May 3 - Royal Bank of Scotland plc's 0% digital notes with fixed buffer due Nov. 30, 2015 linked to the Dow Jones industrial average index should appeal to a broad spectrum of bulls, but the duration may be a concern for some, according to sources.

If the index return is zero or positive, the payout at maturity will be par plus the greater of the digital return and the index return. The digital return is expected to be 14% to 16% and will be set at pricing, according to a 424B5 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 20% and will lose 1% for every 1% that the index declines beyond 20%.

Duration

"It's pretty straightforward. It's a great, clean structure. Just don't like the duration," said Steve Doucette, financial adviser at Proctor Financial.

He said that the notes have the potential to attract a variety of bullish investors.

For instance, very moderately bullish investors with a flattish outlook could outperform the index. Even if the index remains flat at maturity, investors would yield a positive return of at least the digital payment, hence outperforming the benchmark. Mild bulls would also benefit from the minimum digital payout for any increase in the index of less than the digital payment.

Finally, the more aggressive bulls seeking to play the equity markets more safely would not be penalized on the upside given that the notes are uncapped, he said.

"But my concern is the tenor. Three-and-a-half years out - who knows what the Dow will be then?" he said.

Doucette said that having to hold the notes until maturity may represent a risk should a bear market unfold during that period of time.

"If the market is all the way up, you would exceed your digital return and it would make sense to unwind," he said.

"Or it could go down. We've been now three years into a bull market. These cycles don't last forever. We could go all the way up and go down again.

"I just don't like the duration. If it was a one-year or two-year, I may go for it, but 4.3% is not appealing. You stay in and you can take a hit with the index at maturity.

"I might find another way to do this without locking myself in."

Bullish

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said that he likes the underlying and that the duration, while it is an issue, could be managed as part of the liquidity risk.

"I like the asset class. Over the next few years, with the challenges in the global economy, large caps are probably the safest place to be invested," he said.

"The digital payout is close to the dividends on the Dow or the Dow companies.

"We do have an optimistic outlook on the benchmark over the next three years, so I like the uncapped upside. I fact, on a three-year, I just wouldn't do it if the upside was limited.

"And since I'm bullish, I am comfortable with the 20% downside protection."

Asset allocation

Medeiros said that being "locked in" for three years is not such a concern for him given his bullish outlook on the asset class.

"It's important to understand what your liquid and illiquid assets are," he said.

"We're overweight in large caps, so this note would go into an overweight allocation for us.

"We would need to allocate to a more liquid bucket neutral or underweight asset classes. But on this one, large caps, we're overweight, so we could be putting it towards a more illiquid allocation.

"It's part of managing the liquidity risk. And since we are bullish on large caps, liquidity would not be such a concern for us."

The notes (Cusip: 78009PCV1) will price May 29 and settle May 31.

RBS Securities Inc. is the underwriter.

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