JPMorgan's, HSBC's deals linked to MSCI EAFE ETF offer different tenors, possible ladder plays

By Emma Trincal

New York, May 28 - Two issuers have announced leveraged buffered notes linked to the iShares MSCI EAFE index fund, with one deal offering more appealing terms but with a longer duration.

Sources said they can see their clients having a use for both products.

JPMorgan Chase & Co. plans to price 0% capped buffered return enhanced notes due Feb. 4, 2015 linked to the exchange-traded fund, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 1.5 times any gain in the ETF, up to a maximum return of at least 19.3%. The exact cap will be set at pricing. Investors will receive par if the ETF declines by up to 10% and will lose 1% for every 1% that it declines beyond 10%.

The second product has a three-year term instead of the 20-month duration of the JPMorgan notes. But HSBC USA Inc., its issuer, did not cap the upside and introduced a larger buffer.

HSBC plans to price 0% leveraged buffered uncapped market participation securities due May 31, 2016 linked to the ETF, according to an FWP filing with the SEC.

The payout at maturity will be par plus 1.42 times to 1.52 times any ETF gain. The exact participation rate will be set at pricing. Investors will receive par if the ETF falls by up to 25% and will lose 1.3333% for every 1% that it declines beyond 25%.

Laddered portfolio

Dean Zayed, chief executive of Brookstone Capital Management, said that both products could be used in the same portfolio.

"I think those notes would be attractive to some of my clients who have a bullish stand on the market," he said.

"I would buy both, frankly. In the past, we've been laddering a couple of notes with similar terms although with different issuers and different maturities.

"One advantage is you get to diversify across different issuers. That way you can mitigate credit risk.

"You just take the laddered bond approach but apply it to notes."

Both products offer roughly 1.5 times leverage on the upside with a buffer. JPMorgan's 10% buffer has no downside leverage while HSBC's 25% downside protection includes a downside leverage factor of 1.33 beyond the buffer, he noted comparing the two securities.

"I like the basic structure used in these products. Leverage with a buffer is attractive," Zayed said.

Investors would have to be bullish on the EAFE index, he noted. In addition, they would have to be exposed to the headline risk associated with the eurozone, he said.

The underlying ETF tracks the MSCI EAFE index, which measures the performance of the equity markets of 22 developed countries excluding the United States and Canada. Its main constituents include Japan (22%), the United Kingdom (21%) and Australia (8%). One main risk is the large allocation to countries of the eurozone, which makes for about 25% of the index with countries such as France, Germany, Greece, Ireland, Italy, the Netherlands and Spain.

"What would make me cautious is the underlying," Zayed said.

"There is obviously some macro risk with the eurozone, and we are seeing it as a risk. If we see some negative events unfold in that part of the world, it could be an issue. But if that doesn't happen, this index could do well.

"I would use both products in the laddering approach, which would help me diversify across different maturities, issuers and terms.

"Perhaps the three-year would do better. But it's not bad to have one that matures half way.

"If somebody wants the exposure to the EAFE index, those two products in a very similar structure format offer a moderately bullish play. I can see some of my clients being interested in both and buying both." he said.

Euro play

Marc Gerstein, research consultant at Portfolio 123, said that the products were rather similar and that the choice between the two was about duration.

"You could certainly do the ladder portfolio. Those two products are pretty similar. If I had to choose one versus the other, I would tie the decision on how long you want to tie [up] the money," he said.

"The three-year one has no cap. But that's not unusual because on a longer maturity, you would want the full upside.

"Of course, since we're dealing with two different timeframes, your market outlook is essential. Given the strong European weighting, it would really depend on what you think of the eurozone.

"Europe should get its act together, at least I would be hoping, although I don't think anyone on the planet knows what's going to happen in Europe two or three years from now.

"I would like to think that they are somewhat going to get better. The three-year term gives you more time for that.

"With that three-year deal, yes, you have that tricky leverage on the downside. But a 25% buffer is good."

Gerstein said that the impact of the downside leverage factor would be really felt only if the ETF's decline was significant. Even then, the 25% buffer would still be likely to outperform the 10% buffer, he noted.

He assumed a "catastrophe scenario" in which the ETF would decline by 40% at maturity. With the short-term note, the 10% buffer would generate a 30% loss. But the second product, even after leverage, would cost investors 20% of principal.

"That buffer makes a difference," he said.

"And that's for a 40% decline, a pretty catastrophic scenario.

"I may have a slight preference for the longer-term notes. First, there is no cap on the upside. Then you have that 25% buffer on the downside. Yes, you get that downside leverage, but for this to really hurt you, the world would have to be a real mess.

"If we were to see the EAFA index drop 30% or 40%, that would be saying something really bad about the state of the world. If you had such drop in the market, I wouldn't want to be invested in any stock to begin with."

J.P. Morgan Securities LLC is the agent for the JPMorgan product.

The notes (Cusip: 48126NBP1) will price Friday and settle June 5.

HSBC Securities (USA) Inc. is the agent for the second product.

The notes (Cusip: 40432XFT3) will price Thursday and settle June 4.

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