Bank of Montreal's $168.86 million notes tied to Raymond James picks drew large bid for alpha

By Emma Trincal

New York, Jan. 22 - The size of Bank of Montreal's $168.86 million of 0% senior medium-term notes, series B, due Jan. 28, 2015 linked to Raymond James Analysts' Best Picks for 2014 illustrates investor appetite for the firm's equity research brand and stock-picking in general, sources said.

The stocks were selected in December by the equity research department at Raymond James & Associates, Inc. The Raymond James analysts' goal in selecting the Best Picks for 2014 was to identify stocks that will be able to sustain operational growth and price appreciation over a 12-month period, according to a 424B2 filing with the Securities and Exchange Commission.

The notes come on the heels of a similar offering of $185 million sold last month and linked to the same basket.

Best Picks tradition

Each year, Bank of Montreal prices a deal in December based on the next year's best picks. A repeat transaction follows a month later in January.

The size of this repeat transaction, in which only the underlying basket changes, has grown over the recent years. In December 2012, Bank of Montreal priced $100 million of such notes, which were tied to Raymond James Analysts' Best Picks for 2013. The follow-up deal in January 2013 amounted to $88.55 million.

The structure for those Best Picks deals has remained the same: The notes price at 102.75. The payout at maturity is par of $1,000 plus the basket return minus a redemption adjustment amount of $2.50 per note.

As a result, the basket must appreciate by at least 3% for investors to receive an amount that exceeds the issue price of the notes.

Cost

"It's a packaged deal. You get the research. It's probably a lot of marketing effort on the Raymond James side," a market participant said.

Raymond James acted as distributor and received the 2.75% premium in excess of the price to the public, according to the prospectus.

"People, or at least a certain set of investors, prefer to get the package as opposed to buying multiple stocks with all the execution costs associated with that. It can be compelling for some investors who would not be looking forward to doing the single-stock trades," the market participant said.

"That said, the deal is not cheap, but it's a different distribution setup than stocks."

A financial adviser said that the cost was high but warranted.

"The 3% should not really be an issue even if granted, it's a little pricey. But it's justifiable because the analyst picks have outperformed the benchmark every year by an average of roughly 10%. ... That's 10% above benchmark return," this adviser said.

Static basket

Marc Gerstein, portfolio consultant at Portfolio123, objected to the static nature of the underlying portfolio.

"I don't believe in that. No analyst would recommend a basket of stocks for a year no matter what a marketing department would say," he said.

"That type of underlying portfolio would have to rebalance monthly to be credible, maybe quarterly.

"You always have new information affecting stock prices, and the earnings of course. The market changes, time passes."

Raymond James Analysts' Best Picks for 2014 are Advance Auto Parts, Inc., Antero Resources Corp., Apple Inc., Cameron International Corp., Comcast Corp., Copa Holdings, SA, Ctrip.com International, Ltd., Intuit Inc., JPMorgan Chase & Co., Newell Rubbermaid Inc., Praxair, Inc., Quintiles Transnational Holdings, Inc. and Salesforce.com, Inc. Each stock has an equal weighting in the basket.

"It's almost irrelevant what the names are because any investment bank would agree: You can't be locked in for as long as a year without being able to change or rebalance your portfolio," Gerstein said.

Scotiabank deal

In September, Bank of Nova Scotia priced $128 million of equity-linked notes due Sept. 21, 2016 tied to the Raymond James Analyst Current Favorites Total Return index.

The notes were priced at 103% of par, according to a 424B2 filing with the SEC.

The Raymond James Analyst Current Favorites Total Return index was a new index developed earlier that month by Raymond James & Associates, according to the prospectus. It is based on one of the firm's recommended lists, the Raymond James Analyst Current Favorites List, which is published monthly and only available to the company's clients.

"In other words, it was a list refreshed monthly. Well, that's very different. In that case, it's much more reasonable," Gerstein said.

"I'm fine with the idea of a tracker. I just don't like the one-year rebalance. The 3% break-even is on the high side. It sounds like a load fund. You're paying extra to be locked in for one year. I'm not sure why anybody would want to do that. But again, it's not so much the cost or the structure that I don't like. It's the one-year static portfolio."

Track record

According to Raymond James' website, the Best Picks List has outperformed the S&P 500 index by an average of 8.5% over the past 10 years.

Gerstein remained skeptical.

"There may be a track record of beating the benchmark, but the last decade was extremely unusual. You had a big financial crisis and an environment of interest rates going down. Generating alpha in a falling interest rates environment is not the same as doing it when interest rates are potentially rising. That's why I'm not that impressed with track records," he said.

The notes (Cusip: 06366RSG1) priced Jan. 15. BMO Capital Markets Corp. was the agent.

Sources at Bank of Montreal and Raymond James declined to comment.

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