CIBC’s $24.81 million buffered digital notes on S&P 500 seen as a recovery rally spoiler

By Emma Trincal

New York, April 6 – Canadian Imperial Bank of Commerce’s $24.81 million of 0% digital notes due April 6, 2023 linked to the S&P 500 index would have been a good way to play a sideways market. But advisers said the notes are not timely due to the limited upside, which could cost investors the opportunity of profiting from a market rebound.

If the index return is greater than or equal to its initial level, the payout at maturity will be par plus 26%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index falls by up to 17%, the payout will be par. Otherwise, investors will lose 1% for every 1% that the index declines beyond 17%.

On the way up

“I wouldn’t consider it,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

While the 26% digital return was attractive in a flat or sideways market, it also caps the upside if the index rises above it.

“I usually don’t like caps, especially now as you’re coming off the lows,” he added.

Kunhardt was somewhat optimistic about the chances of a market rebound.

“We’re having a pretty good day today.

“Many are projecting that we hit the bottom on March 23. We haven’t been anywhere near that level since.”

On March 23, the S&P 500 index hit its low point at 2,191.86, down 30% from its Feb. 19 high.

Since then, the benchmark has jumped more than 21%, closing at 2,663.68 on Monday. But it’s still technically in bear market territory, down 21.5% from its February high of 3,393.52.

“We’re on the way up,” said Kunhardt.

Opportunity cost

“It’s when a market is coming off a correction that typically the biggest gains are to be made.

“So, I think the cap is a negative in this deal.

“I’m always about managing risk on the downside and it’s great to have a buffer.

“But given the level of the S&P, I would be willing to take a smaller downside protection for more upside.

“The opportunity risk is just too high.”

It’s also important not to miss the next leg up since clients have lost so much during the recent sell-off, he noted.

“You’re never going to be able to make up for the losses if you cap your upside at 26% for three years. You need to be able to regain some profits.”

Wrong comparison

Some analysts predict that the recent uptrend is only a “bear rally” and that more downside is to be expected.

Kunhardt did not share such opinion at all.

“I know. Some people compare this market to 1929-30. It’s a bogus comparison,” he said.

After the 1929 crash, the market was already recovering, he said.

“It’s a series of poor economic decisions that cut the legs out from the recovery and took us to the Great Depression.”

Today’s situation is very different, he argued.

“This is not a downturn. This is a response to a public health issue.”

News-driven

The S&P 500 index rose by 7% to 2,663.68 on Monday on hopes that the Covid-19 death toll was showing signs of slowing down in Italy and Spain as well as in New York, the epicenter of the epidemic in the United States.

“Anytime you have bad news about the coronavirus curve, the market drops. Today we had good news: the number of new cases seemed to slow in New York and New Jersey. The Dow is up 1,600 points,” he said.

“The market is driven by whatever health news there is.”

Great terms

Michael Kalscheur, financial adviser at Castle Wealth Advisors, stressed the quality of the terms even if he would not consider the notes either.

“You win on the terms. You win on the fee. You win on the buffer,” he said.

“The terms of this deal are really impressive.

“The 25 basis points fee arguably makes this note one of the least expensive I’ve ever looked at.”

Kalscheur who pays close attention to downside protection was also “impressed” by the 17% buffer.

“Not only is this a good size buffer but it’s not a barrier.”

Kalscheur assesses risk with back testing analysis using data he has compiled on the S&P 500 returns since 1950. Since the past 70 years, he said, the S&P 500 index, on a three-year rolling period, finished below 17% only 8% of the time.

“You can go to a client with a straight face and tell them that historically, the chances of being down more than the buffer are only 8%.

“Even if it’s lower, you’re still leading the market by 17%, which is great.

“I don’t think any client is going to complain about that.”

Low cap

The “caveat” however was the limited upside, he said in line with Kunhardt’ view.

“The cap is not big enough especially when you take into consideration where we are today.

“90 days ago, I would have said: okay. The market is a bit overvalued. I might consider it.

“But in this environment where the Dow is at 21,000, 22,000, not 29,000, I don’t think capping your upside at 8% is a good fit for what we see out there in the market.”

High-yield alternative

Kalscheur in general prefers to avoid capping the upside even if it means extending the duration to five year or even longer.

“When I take equity risk, I want equity-like returns. If I’m going to be conservative, I’m not going to get a capped return.

“I’d rather go to a high-yield bond fund. At least, I’m not locked in for three years.

“I can get a competitive yield. Granted, it may not be 8% for the next three years. And high-yield bonds have been decimated. You have to worry about solvency. But those funds are well diversified. You can get hundreds, even thousands, of bonds in a high-yield ETF.”

Very cautious play

The notes may still be a good match for a particular type of investor.

“For the nervous client, someone who is not bullish for the next three years, it’s not a bad note.

“But I can’t get excited about that.”

Anticipating a recovery within that timeframe or even later, Kalscheur is seeking uncapped leveraged notes now.

“I’d rather spend money to get leverage on the upside so I can participate in the rebound once the market goes back up again,” he said.

CIBC World Markets Corp. is the agent.

The notes (Cusip: 13605WWX5) settled on Monday.

The fee is 0.25%.

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