Citigroup’s buffered notes tied to MSCI EAFE aimed at short-term bulls

By Emma Trincal

New York, Jan. 26 – Citigroup Global Markets Holdings Inc.’s 20- to 23-month 0% buffered notes linked to the MSCI EAFE index offer downside protection and leverage over a short period of time, but financial advisers were not totally comfortable with the buffer size in one case and with the cap on another.

What makes the pricing of the product so challenging is its very short duration, a term that could be modified to enhance either the protection or the return, they said. At the same time, the notes will appeal to short-term investors with a bullish view.

If the final index level is greater than or equal to the initial level, the payout at maturity will be par plus 150% of the index return, subject to a 20.47% to 24.07% cap, which will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index declines by 12.5% or less and will lose 1.1429% for every 1% that it declines beyond 12.5%.

Cap on return

“I don’t like the terms of this structure,” said Matt Medeiros, president and chief executive of the Institute for Wealth Management.

“I like the asset class, and I’m not a fan of a cap.

“If the cap is there because it’s a short maturity, then I will probably pass.”

The EAFE index tracks the performance of developed countries at the exception of the U.S. and Canada. It is heavily weighted in the European stock markets.

Double-digit gain

Both the cap and the term are disclosed within a range in the prospectus. But investors depending on the final terms are still expected to receive double-digit returns in a 10.20% to 13.85% range on an annualized compounded basis.

Medeiros explained that he is not satisfied with these levels because he tends to expect more from an area that has long underperformed the U.S. markets.

Since 2013, the S&P 500 index has consistently posted excess returns over the MSCI ETF averaging 10 percentage points in the past four full years. The U.S. benchmark outperformed the MSCI EAFE by 2.25% in 2015, its lowest relative performance, and by 18.60% in 2014.

Bullish play

“I’m bullish on these markets. I think the sector will rebound,” he said.

Part of the growth will be driven by a stronger U.S. economy, he predicted.

“Looking at the U.S. GDP numbers, taking into account the new policy changes that will be implemented –tax cuts and less regulation –we’ll have a more business-friendly environment. All these things should have a positive impact on growth and therefore create more opportunities in Europe.”

Medeiros said he was not opposed to a cap, when the cap is “in line” with the return expectation of the underlier.

“But I think in this case, it will limit the investment opportunity,” he said.

Mean reversion

Steve Doucette, financial adviser with Proctor Financial, was on the other hand more concerned about the amount of downside protection.

“It’s kind of a vanilla note. It’s got a pretty broad range between a 12% buffer and a 20% cap, somewhere in a range of 10% a year,” he said.

Doucette believes that the trend of the MSCI EAFE index consistently underperforming the S&P 500 index is not sustainable.

“[The EAFE index] hasn’t performed nearly as well as the U.S. indices.

“I believe that history does repeat itself. They haven’t caught up yet. But at some point they will. Eventually things will revert.

“They will go up more or go down less. The question is when,” he said.

Playing it safe

Betting that the EAFE index eventually will stop lagging the S&P 500 index is not the same as being bullish on this asset class.

“A bear market is a 20% decline. They could go down 20% while the S&P drops 30%. Every five or six years there is a 20% adjustment. I would look at increasing the buffer,” he said.

Doucette said he would want more downside protection without giving up the cap as it is.

“I would be looking at extending the duration. You can also give up a little bit of leverage...Maybe a combination of everything.

“It’s a great structure. I’d just have to play with it a little bit.

“When you bid on these notes, you may have some good surprises from these issuers because they want the business.”

Citigroup Global Markets Inc. is the underwriter.

The notes are guaranteed by Citigroup Inc.

The Cusip number is 17324CEA0.

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