Tenor on RBC’s barrier booster notes tied to S&P seen as too lengthy despite strong barrier

By Emma Trincal

New York, Feb. 25 – Royal Bank of Canada’s 0% barrier booster notes due May 29, 2026 linked to the S&P 500 index give investors the potential to outperform the market both on the upside and the downside and within a range.

But advisers were not totally comfortable with the six-year maturity.

If the index return is greater than the booster percentage, the payout at maturity will be par plus the index return, according to an FWP filing with the Securities and Exchange Commission. The booster percentage is expected to be 30% to 40% and will be set at pricing.

If the index return is zero or positive but does not exceed the booster percentage, the payout at maturity will be par plus the booster percentage.

If the index return is negative but greater than or equal to negative 30%, the payout will be par.

If the index return is less than negative 30%, investors will lose 1% for every 1% that the index declines from its initial level.

Good pricing

“In the -30% to +30% range, you get an improved outcome paid for by the dividend,” said Jonathan Tiemann, president of Tiemann Investment Advisors.

He found the barrier particularly compelling.

“Although you don’t have complete downside protection, 30% is a pretty defensive barrier.

“It’s probably priced OK. But the tenor is awfully long.”

Since the notes are not callable, the duration will be the same as the tenor. Investors can always sell the notes prior to maturity. But a secondary market is not guaranteed.

“Usually, the time you’d really like to sell is not always going to give you the price you’d like,” he said.

Solid barrier

The odds of being down more than 30% in six years are “pretty small although it’s certainly possible,” he added.

The product could provide a partial hedge to a long position.

“If you are already invested in the market or have a good reason to be long, it’s not a bad bet to make.”

Tiemann said that even during extreme periods covering the financial crisis investors were unlikely to lose more than 30% point to point within a six-year interval.

“The odds of being down by that much are so slim, I think you could even reduce the barrier size a little bit to get better terms. You may be a little happier with a 75% barrier.

“But the benefit of this note is peace of mind. You are pretty well protected not that it’s perfect.

“The only thing I don’t like about this note is the longer tenor.”

Way too long

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, did not like the long tenor either. But unlike Tiemann he did not expect less risk over the longer period even though he agreed that the barrier offered a decent size.

“The six-year for me is too long, way too long,” he said.

“The challenge I see is that we’re at the end of a bull market. Things tend to be a lot more volatile at the end.

“You can’t really time the next cycle. It will depend on when the next recession starts.

“If we have one today, it might be OK. But we don’t know exactly when it will happen. And even though the barrier is nice, I would want more protection for such a long timeframe.”

Bearish outlook

Back-testing analysis often shows that risk is reduced over a longer stretch of time. Chisholm opposed this view on a forward-looking basis.

“People think that probabilities of losing money over the long term are small. But that’s because they look at history. History doesn’t repeat itself,” he said.

“You have to take into account where we are in the current bull market. We are at the end of it. The risk is a lot higher at the end of a bull market than at the beginning.”

The current bull market, which began in March 2009, is the longest one in history.

“Valuations are very high. The probabilities of losing money at the end of this six-year period are higher. The next few years are going to be ugly,” he said.

“I don’t have any intention to lock up my money during that time. I’d much rather be in cash so I can take advantage of opportunities.”

RBC Capital Markets, LLC is the agent.

The notes will settle on Feb. 28.

The Cusip number is 78015KMX9.

© 2015 Prospect News.
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