Citi’s buffer securities on MSCI EAFE index offer value, growth via underlier, upside payout

By Emma Trincal

New York, March 29 – Citigroup Global Markets Holdings Inc.’s buffer securities due March 31, 2026 linked to the MSCI EAFE index give uncapped leveraged exposure to an undervalued asset class, which, according to advisers, is an attractive formula despite the long tenor, as it combines growth and value within one trade.

The payout at maturity will be par plus 1.46 times any index gain, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 10% and will lose 1% per 1% drop beyond 10%.

Core

Carl Kunhardt, wealth adviser at Quest Capital Management, said he would consider the notes.

“There’s only one thing I don’t like and it’s the term. But I like the note,” he said.

“As always, my first question is: are developed non-U.S. stocks a core holding? And the answer is of course it is a core holding.”

The EAFE does not include any developed market in the Americas. Its top allocation is Japan with a 25% weighting. Australia makes for 7% of the portfolio, Hong Kong more than 3% and Singapore, 1%.

“If you exclude Japan and Australia, basically all you’re really left with is Europe. There’s nobody else,” he said.

About 60% of the portfolio consists of European companies. The largest country and second allocation is the U.K. with a 14.16% weighting.

“It’s always overweight Europe. Anywhere between 60% and two-thirds,” he said.

“Whether you look at it as non-U.S. developed markets or Europe, it’s a core holding.”

Trade-off

The second question Kunhardt asks himself when considering a structured note is whether he is “better off” holding the asset class long or with the note.

“In this case, since I’m going to hold the position anyway, this leverage is giving me more upside potential and the buffer, some downside protection. I’m getting additional benefits on both sides of the line. And it’s the EAFE, the major international index, an asset class I’m going to hold anyway,” he said.

“So yes, I would do this note even though you have to commit to five years. But in this case, it makes sense.”

“The benefits you get from the note offset the five-year issue,” he said.

Creditworthiness

Steven Foldes, vice-chairman of Evensky & Katz / Foldes Financial Wealth Management, held a similar view: despite its tenor, the product offered significant appeal.

“This is an interesting note,” he said.

“First the credit rating of the issuer is fine. We have no problem with that.”

The five-year credit default swap rate of Citigroup is 54 basis points, according to Markit, which is tighter than Morgan Stanley’s 57 bps, Goldman Sachs’ 59 bps and Wells Fargo’s 61 bps. Bank of America and JPMorgan showed tighter spreads of 49 and 47 bps, respectively.

“The fact that you have 1.46 times leverage with no cap is certainly compelling,” he said.

“We don’t love five year, but you get a great deal of leverage.”

The underlying was also a good choice.

“In a globally diversified portfolio, the EAFE is the broad benchmark for international developed stocks. We use it on our portfolio, so having the leverage is very nice,” he said.

Breaking even

Noteholders, as it is the case for all structured notes, will not receive any dividends with respect to the underlying index. The MSCI EAFE index yields 2.1%.

“This note is for investors who are optimistic about this market,” he said.

“They’re giving up over 10% worth of dividends over the life of the notes. You need the benchmark to be up at least 5% a year to be able to make up for this. You need to be optimistic about the asset class, which we are.”

Laggard

Part of Foldes’ bullishness on the index derived from its relatively low valuation.

“The asset class hasn’t really taken off yet. Covid is still more of a problem there than it is here. It will change as vaccine distribution improves in Europe,” he said.

“Europe, Australia, Asia and the Far East will come out ahead.”

Since 2011, the MSCI EAFE index has only outperformed the S&P 500 index twice – in 2012 and 2017 – by 1.38 and 3.25 percentage points, respectively, according to Morningstar.

During those past 10 years, the U.S. benchmark has outperformed the MSCI EAFE index by more than 10 percentage points on average.

For the year, the S&P 500 index is up 6.17% versus 3.17% for the EAFE through March 26.

Restructuring

The five-year term was a concern. But it was not an unsurmountable obstacle.

“We don’t love five-year notes. They tend to be too long,” added Foldes.

“Having said that, if we decided to refashion this note, we would look at this 10% buffer, which I’m not sure is necessary over a five-year period especially given the valuations for these non-U.S. assets... it’s very unlikely you’d see a 10% decline.”

Foldes would be negotiating two areas.

“If we gave up the buffer, what would that look like in terms of the leverage? What would that look like in terms of reducing the term of this note?

“That’s the type of conversation I would have with the issuer. Whether I would lean toward increasing the leverage or shortening the note would depend on pricing.”

Many good points

But overall, Foldes found the deal appealing.

“Having a leveraged note with no cap in an area that has underperformed the U.S. market and is due for a bounce back is attractive,” he said.

“1.46 times is significant. Having no cap is extremely important. We like that. It’s especially important when the asset class takes off, which is really possible given the underperformance of this index.

“Finally having a buffer is nice although we don’t think necessary.

“The combination of the uncapped leverage with a major asset class that appears to be undervalued over the past few years as it relates to the U.S. makes this note really interesting.”

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes were expected to price on March 26 and to settle on March 31.

The Cusip number is 17329FAA2.

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