JPMorgan’s $505,000 autocall notes on index, ETF offer fixed income substitute, adviser says

By Emma Trincal

New York, Aug. 9 – JPMorgan Chase Financial Co. LLC’s $505,000 of autocallable contingent interest notes due Aug. 8, 2025 linked to the lesser performing of the iShares Russell 2000 Value ETF and the Russell 2000 index may fit into the fixed-income bucket of a portfolio, a financial adviser says, pointing to a low barrier and competitive yield. But another adviser warned against the recent bounce in the market making the entry price of both underliers less attractive and therefore riskier than it was about two months ago.

Investors will receive a coupon of 10.3%, paid monthly, if each underlier closes at or above its 70% coupon barrier on the related monthly observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The securities will be called automatically at par if the closing level of each underlier is greater than or equal to its initial level on any monthly review date starting Nov. 7.

At maturity, the payout will be par unless the worst performing asset finishes below its 60% trigger level, in which case investors will be fully exposed to the decline of the worst performing asset.

Worst-of

Both underliers have dropped significantly from their recent highs, noted Tom Balcom, founder of 1650 Wealth Management. The Russell 2000 index and the iShares Russell 2000 Value ETF closed on Tuesday more than 15% off their respective November highs.

“With a worst-of, you don’t know what you’re exposure is going to be,” he said.

“I tend to think the Russell 2000 will outperform the ETF. One positive here is the high correlation between the two. Anytime you’re using a worst-of payout you’re underperforming the best-performer of course. But a high correlation helps reduce the gap.”

The coefficient of correlation between the two underlying assets is 0.98.

Fixed-income

Investors buying the notes should decide where to allocate the securities, he said.

“The 10.3% coupon is high but not high enough for make it part of your equity bucket,” he said.

“To me the note is more of a fixed-income substitute especially with that 60% barrier at maturity. 60% is a healthy protection level over three years.

“As a fixed-income replacement the 10.3% coupon gives you a better chance to outperform most fixed-income instruments.”

Short no-call

The only downside of the note is the limited call protection, he said.

“After only three months, you can be called with a 2.56% coupon. It’s not bad of course, but it’s not very practical. You just held the notes for three months and you now have to find another source of income. Maybe you would do that because one client wants to use the note. But it’s not very time-efficient for the adviser,” he said.

Portfolio, high correlation

The iShares Russell 2000 Value ETF just like the Russell 2000 index are highly diversified underliers, he noted.

The ETF has 1,408 holdings and the top weighting is 0.5%.

“But you have a high concentration in three sectors – finance, industrials and health care,” he noted.

All three sectors make for more than 52% of the portfolio.

Not all three sectors have a positive outlook, however.

“While rising interest rates for instance is a positive for banks, industrials stocks could suffer from inflation,” he said.

In conclusion, Balcom said he liked the current entry prices, the “conservative” barrier at maturity, the double-digit coupon and the high correlation between the underliers.

“The only issue I have is the short duration. The notes may very well be called in three months, which put an end to your income stream and forces you to find a new income strategy,” he said.

Late timing

A financial adviser said the structure was “favorable” but “unfortunately” the timing was not.

“Both assets have bounced back from their recent lows. The bear market started late last year for those two underlyings. But since the middle of June, we’ve been in a bear rally,” he said.

Both the Russell 2000 index and the iShares Russell 2000 Value ETF have jumped more than 16% since their respective 52-week lows mid-June.

“After such a big bounce, it’s probably not such a good idea to buy right now, especially as we’re likely to enter soon the most severe part of the bear market,” he said.

Some income

On the other hand, the notes are not bullish, and the term is long enough to allow for some coupon payments, he said.

“The chances of being called are small in my view. At the same time, you have a three-year timeframe. You could very well be collecting some coupons along the way because it may take some time for the market to drop 30%. Will you collect all the coupons? Probably not. But you may get many of them.”

The chances of breaching the 60% barrier at maturity depended on the severity of the bear market, which is unpredictable, he noted.

However, based on the historical average length of bear markets cycles, investors had a chance to get their money back at maturity.

Principal repayment

“There is a chance that you will earn some income and finish with 100% of your principal back. But it’s a worst-of and we’re not done with the bear market. So, there’s still a real risk. Between July 2007 and March 2009, the Russell 2000 fell far more than 40%.

“On the other hand, we’re not starting at a peak. We’re still high but not at the top of the top,” he said.

Given the principal at risk at maturity and a return capped at the 10.3% coupon level, this adviser questioned the soundness of the risk-adjusted return.

“It seems like a speculative bet,” he said.

“Some people like driving at the end of the cliff. With this note, you won’t know if you’ll end up losing money or not until the final weeks.

“That’s your call,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes will settle on Wednesday.

The Cusip number is 48133LX98.

The fee is 0.94505%.

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