Scotia’s $5.12 million leveraged notes on MSCI EAFE offer exposure to lagging underlier

By Emma Trincal

Buffalo, N.Y., Jan. 18 – Bank of Nova Scotia’s $5.12 million of 0% capped buffered enhanced participation notes due July 18, 2025 linked to the MSCI EAFE index can provide double-digit returns, which may satisfy mildly bullish investors. But for others, the cap is too limiting considering the index’s underperformance and the possibility of positive events that could act as catalysts turning a laggard into a high-growth index.

If the final index level is greater than the initial level, the payout at maturity will be par plus 250% of the index return, subject to a maximum settlement amount of $1,203.75 per $1,000 principal amount of notes, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index finishes flat or falls by up to 12.5% and will lose 1.1429% for each 1% index decline beyond 12.5%.

Several countries

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he liked the risk-adjusted return of the notes based on the current global environment.

Investing in the note would require some preliminary research, however.

“I’m not that familiar with Scotia Bank so I would have to do more due diligence on them,” he said.

“There’s potential for a soft-landing scenario in Europe but there are still reasons to be skeptical. Each country will have to come up with their own soft landing. Europe, Japan, Australia... They all have their own monetary policy. Some may or may not follow the Fed in its easing path.”

Acceptable cap

The EAFE index is overweight Europe.

Stocks of European companies represent 62% of the MSCI EAFE index. The top country though is Japan with a 23% weighting. Australia has a 7.3% weighting.

“I’m not pessimistic about Europe but I’m not bullish either. So, I’m not really worried about the cap,” he said.

“I would be happy with a high single digit return over the 18-month term. The leverage makes the note very attractive.”

The 20.37% cap over 18 months is the equivalent of a 13.2% annualized compounded return, which can be achieved if the index grows by only 5.45 a year.

Uncertainty

Medeiros liked the downside protection as well.

“The 12.5% buffer is I think very efficient for this 18-month timeframe,” he said.

“I’m not a fan of geared buffers but it’s more efficient and defensive than a barrier.”

The EAFE is also a less volatile asset class than the S&P 500, he noted.

“That’s another reason why I’m comfortable with this protection level,” he said.

The combination of the leverage and buffer associated with a “reasonable cap” illustrated the benefit investors may gain from structured products in general, he noted.

“With the uncertainty we’re seeing in the markets, structured notes offer attractive solutions. They can help define your outcome more specifically. You can maintain exposure with some downside protection while still getting good returns. This note is an example of this,” he said.

Laggard

A financial adviser said he liked the issuer and the exposure to the asset class. But the cap, he said, was a “deal-breaker.”

The EAFE index has been underperforming for a long time, he said.

“It’s been a drag on a portfolio for many years. You would expect a reversion to the mean even if it has not happened for an extended period of time,” he said.

Since 2014, the MSCI EAFE index has only outperformed the S&P 500 index twice: in 2017 and 2022, according to Morningstar.

There were times however when the EAFE outperformed the S&P 500 index, in particular during the “lost decade” of the 2000’s, he noted.

Advantages

This adviser said he allocates to the EAFE index.

“We like having international exposure. There are reasons to invest internationally. You want to have a globally diversified portfolio, so the EAFE exposure makes sense. That aspect of the notes we like,” he said.

“The 1.5-year term of the note is fine. We like notes that are on the shorter side.”

This adviser added that he was comfortable with the issuer’s credit.

The Bank of Nova Scotia is rated A+ by S&P Global Ratings. In comparison, JPMorgan and Morgan Stanley received an A- rating while Goldman Sachs has a BBB+ rating.

He pointed to other positive terms:

“Having a 12.5% buffer is very nice too on an 18-month. The index could be down,” he said.

“And 2.5x leverage is great. You can’t complain about that.

“The problem is the cap.”

Turning points

This adviser was concerned to be missing a catalyst, which could significantly boost the performance of the underlying over the period.

“In 18 months we could have a cease-fire in Ukraine, or perhaps even peace in that part of the world and that would be a huge benefit for European markets You wouldn’t want to miss that. You may also have interest rates in Europe coming down,” he said.

Several geopolitical or economical catalysts could lead to an “explosive” growth, he added.

“If you don’t participate in it, you would do your client a disservice,” he said.

For this adviser, the cap would have to be either raised or eliminated.

Restructuring the notes

“The big thing here is the cap,” he said.

He explained how he would refashion the notes.

The first step would be reducing the leverage to get a “much higher” cap.

“I would much rather bring down the leverage to 1.5 if I can get a significantly higher cap,” he said.

A second possibility would be to extend the maturity of the notes in order to raise or eliminate the cap.

“Ideally, we would rather not be capped at all. But if it has to be a two-year, I would like to see a much higher cap than what it is right now,” he said.

This adviser said that a higher cap was all the more justified given the high dividend yield of the index, currently at 3%.

“You are losing 4.5% in dividends over the period. That’s another reason to increase your return.

“For us, a low cap is a non-starter,” he said.

Scotia Capital (USA) Inc. is the underwriter. iCapital Markets LLC is the dealer.

The notes settled on Thursday.

The Cusip number is 06417YE96.

The fee is 0%.

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