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Published on 9/15/2014 in the Prospect News Structured Products Daily.

Scotiabank’s notes tied to Raymond James current favorites index to offer top picks, access

By Emma Trincal

New York, Sept. 15 – Bank of Nova Scotia is prepping its third issue of notes tied to a Raymond James proprietary index designed to offer investors the equity research firm’s best stock picks analyst by analyst.

Bank of Nova Scotia plans to price 0% equity-linked index notes due Sept. 22, 2017 linked to the Raymond James Analyst Current Favorites Total Return index at an issue price of 103, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus the index return, which could be negative. Due to the 103 issue price and an index adjustment amount, investors will receive less than their initial investments if the index does not increase by at least 4%. The index adjustment amount is $1.25 per $10 note.

The first deal came out Sept. 18 of last year with Bank of Nova Scotia’s $128 million principal amount of equity-linked notes due Sept. 21, 2016 tied to the Raymond James Analyst Current Favorites Total Return index. It was one of the top deals for that year in size.

The notes priced at 103 for $131.84 million of proceeds.

The second offering, which also priced at 103, came out in March for $72.1 million of proceeds.

The bank intends to “do a tranche every six months,” a source said.

Best picks monthly

The Raymond James Analyst Current Favorites Total Return index is a proprietary index that aims to track the performance of the Raymond James Analyst Current Favorites List, on an adjusted basis.

The Raymond James Analyst Current Favorites list, updated regularly, reflects the current top stock ideas of the analysts in equity research. It must have a strong buy or outperform rating, the two top ratings issued by the firm.

The index is rebalanced monthly while the list can change on a daily basis.

Sources evaluated the pros and cons of investing in a relatively expensive product to get access to a proprietary research only available to clients and advisers of Raymond James.

The overall fee is about 4.25% when adding the 3% sales concession, which constitutes the premium and the 1.25% adjustment fee.

No need to trade

Carl Kunhardt, wealth adviser at Quest Capital Management, whose firm is affiliated with Raymond James, said that “the fees are justified for a couple of reasons.”

The first reason was to save investors time and commission costs from trading the stocks themselves.

“The notes are available to Raymond James clients only so in theory you could trade the stocks yourself. But the list can change every day. If you had to do it yourself, you’d have to go out and deal directly with a discount broker. You’ll have a bunch of trading fees. They rebalance the index every month, adding one, dropping one. You’re not trading for free. That’s number one,” he said.

“Number two, it’s worth paying the fee if you see value in the list. If you believe it makes sense to get exposure to that type of research, then the fee is certainly appropriate. It’s up to you.

“We wouldn’t pay attention to that. It’s just not our business model. We don’t do individual stocks. We don’t spend a lot of time on analysts’ picks.

“But for some clients, stock-picking is very important. I suspect this is going to be more of a product sold by Raymond James’ brokers at Raymond James & Associates rather than the independent affiliates that tend to operate more like financial planners.”

Track record

Raymond James’ equity research is considered to be among the best for small-caps and mid-caps in the United States, sources said.

For the first half of the year, the Analysts Current Favorites picks generated a 6.6% gain versus 3.2% for the Russell 2000 Total Return index, according to Raymond James.

Last year, Raymond James analysts recorded a 46.2% gain versus 38.8% for the Russell. The list outperformed the small-cap benchmark by nearly 5 points last year and by almost 4 points in 2011. In 2010 however, Raymond James analysts with a 22.4% return underperformed the Russell by 4.4%.

“That’s impressive. Anyone seeing those numbers would agree that it’s pretty good,” said Michael Kalscheur, financial adviser at Castle Wealth Advisors.

“You’re investing in an index that has a solid track record.

“It’s not like the S&P and the Dow Jones. I’d have to explain to my clients what it is, but if the performance is good, it’s worth doing some explaining.”

The fee issue

However, Kalscheur said the cost of this investment was high.

“You have the embedded fee. You’re issuing at 103 and redeeming at 100. It’s essentially a load. If it was only that, I would say the fee is a little bit high but it’s not egregious on a per year basis. But you also have the adjustment fee on top of this. It starts to add up.”

But a market participant said that pricing at a premium was not necessarily a disadvantage.

Transparency

“I like the fact that the 3% sales concession is built in the premium, People get to see it. There’s no hidden fee,” this market participant said.

“To me it’s more transparent to mark it above 100. Clients pay 103 upfront. There is a front-load but you know what your fee is. It’s a three-year so you’re up-fronting 100 bps a year. I know that in the industry it’s done differently. Clients put 100 in the account and they only have 97 invested. I would think you would want to pay commissions like a stock, which is how it’s done here. You get the real value. One way or the other, it’s the same. Investors are still paying 3%.”

This market participant said about the 1.25% adjustment factor, that it was “an ongoing administrative fee,” which is “no different from what you see” with other investment vehicles.

“It’s the retail market,” he said.

“You see some UITs at 400 bps.

“You have some closed-end funds that may charge 4.75% in fee trading below par so you get 95.25 invested.

“Plus, if you don’t have sufficient secondary market, those closed-end funds have a tendency to trade at a discount because there’s no liquidity. They keep on dropping in price, which obviously is bad. They lose value until some institutional investors come in to provide liquidity.”

For this market participant, the underlying index may provide enough value to justify the costs.

Value

“A lot of people are cognizant of fees and they should. But given the performance of Raymond James research, this gives you something quite unique. This is not a passive index. You get the expertise of 40 Raymond James research guys providing their expertise. That doesn’t come free to Raymond James,” he said.

“It’s not a static basket like those notes that lock up your money for several years. You have a bad market event, a corporate crisis in one of your companies and your basket price drops all of a sudden. You have no control. This index is rebalanced monthly. It captures a real time perspective of the research. That’s the major difference.

“You can do a note on the S&P for 20 basis points a year, sure. But this is not the S&P,” he said.

Delta one

For some buysiders though, access is was enough.

“The structure of it is problematic,” he said.

“It’s just one-to-one on the upside and on the downside. That’s my biggest surprise. Why would I lock myself in for three years to get in return nothing else but access? Because this is an access play and nothing else. You have no leverage on the upside, no buffer on the downside.”

Whether the fee was worth paying depended on the value that investors would assign to Raymond James’ research but also to the size of their portfolio, he noted.

“This deal is only available to Raymond James clients. But those are investors who have access to the list. In that case, can’t you buy the stocks on your own?”

Retail benefit

He did a “back of the envelope” calculation assuming a $100,000 portfolio; a total of 40 stocks in the Current Favorites List; a 25% rotation of the list each month; and a $10 per trade commission on each stock transaction.

“Ten trades a month for three years at $10 a trade would be $3,600 or 3.6% of your portfolio,” he said.

“This example shows you’re better off doing the trades on your own. It would be cheaper.

“Obviously I assumed that the client had $100,000 to invest. It looks like for smaller accounts, the notes may be more cost-efficient.

“So I guess it depends on who you are.

“But regardless of size, the notes are convenient. Their index can save you time. They readjust the portfolio for you each month so you don’t have to do it yourself.

“Still, I am not too sure I like the idea of having nothing but one-to-one in a note no matter what I’m getting access to,” he said.

Exclusive offering

The notes however offered the advantage of paying noteholders the dividends paid on the index components.

“This is significant. You almost never have the dividends when you invest in a structured note. This one gives you the total return, and that’s rare,” he said.

“Hence, that’s why you don’t have any downside protection or leverage here.

“But at least it’s apples to apples. If I go out and buy the stocks directly I’m on the same level playing field.

“This is not a typical structured note. If I only have $10,000 to invest, maybe that would be a worthwhile endeavor.

“Some small accounts familiar with Raymond James research might be interested in getting exposure to this index.

“I’m just surprised they’re offering this to Raymond James clients only and that they’re not opening up the deal to the general public.”

The notes (Cusip: 064159) will price on Sept. 19 and settle on Sept. 24.

Scotia Capital (USA) is the underwriter.


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