JPMorgan’s $2.24 million leveraged notes tied to SPDR metals ETF have disappointing premises

By Emma Trincal

New York, Oct. 26 – JPMorgan Chase & Co.’s $2.24 million of 0% capped buffered return enhanced notes due Dec. 28, 2016 linked to the SPDR Metals & Mining exchange-traded fund were probably designed for contrarian investors betting on the recovery of a distressed sector, sources said.

Unfortunately the structure does not reassure bears concerned about volatility nor does it appeal to bulls, who object to the cap given the potential for the sector to bounce back, according to buysiders.

The payout at maturity will be par plus 1.2 times any gain in the fund, up to a maximum return of 20%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the fund falls by up to 15% and will lose 1.1765% for each 1% decline beyond 15%.

The fee is 2.15%.

Carl Kunhardt, wealth adviser at Quest Capital Management, said he is bearish on the underlying equity fund.

The SPDR Metals & Mining ETF replicates an index carrying the same name, which represents the stocks of companies in the metals and mining industry.

The top three stocks in the fund are Stillwater Mining Co., Royal Gold Inc. and Alcoa Inc.

China

“I wouldn’t touch it because of the underlying,” said Kunhardt.

“The structure is a moot point because of the premises of the notes. ... I don’t see any advantage to it.”

“It’s a stock fund, not a commodity fund, I understand that. But it doesn’t matter if it references commodities or not. If it’s a stock in mining or metals, the company is in commodities, and commodities are in the tank. Everyone expects them to be in the tank over the next 14 months. As a result, the stocks of those companies are not going to do well.

“It’s not an accident if metals are not doing well ... if silver, steel, aluminum are getting hammered.

“It’s because China is not buying that stuff. If they’re not buying it, it’s not going to get better.”

The fund is down more than 42% so far this year. Even over the past five years, it posted a 67.5% loss.

Slowdown

“Would I want to play the contrarian game? Investing when there is blood on the Street? Possibly if the note was a 60-day, not a 14-month. I’m not going to take that kind of risk on a 14-month,” he said.

The fact that the underlying fund excludes energy, an also very negative sector, offers limited comfort.

“OK, there’s no oil in there. So instead of a 50% decline, you’ll have 30%. With the geared buffer, you only lose 17%. But you know what? I can’t really see myself sitting in front of a client telling him, ‘look we only lost 17% instead of 30%.’ It’s not the kind of conversation you want to have with a client.”

The negative sentiment around commodities and China reflects a general unease in the market about global growth, he noted.

“The economic slowdown is not just a problem in China. The U.S. economic growth is anemic. Europe and Japan are even worst,” he said.

“If the growth of the global economy is slow, it doesn’t matter how much of this stuff you pull out of the ground because you’re not selling.”

Missing the rally

Steven Foldes, vice chairman at Evensky & Katz/Foldes Financial Wealth Management, holds a different view. His concern is the upside return limitation in a sector that may potentially regain favor.

“It’s not that I don’t like the underlying. I don’t like the notes,” he said.

“The fact that it’s a shorter period is a good thing, but the 2.15% fee on 14 months is expensive.

“However, what I really don’t like here is the cap, especially for something like the metals and mining, a market that has been beaten down.

“If you invest in this, you have to believe in a big bounce. In the past month alone, the fund has already gained 5%.

“If there is a breakout in 14 months, I certainly don’t want to limit my upside to 20% when the breakout may be very, very robust.

“The 20% cap on 14 months would be a non-starter for me, particularly on something as deeply depressed as this sector.”

Buffer

In addition, the downside protection is not sufficient in his view.

A 15% geared buffer is still preferable to a barrier of the same amount since investors only incur leveraged declines after the 15% threshold, he explained. But the percentage amount of protection is still not enough given the high volatility of the underlying fund.

“The 15% buffer is the tip of the iceberg,” he said.

“In the past year, this ETF has lost more than 48%.

“A 15% protection on something stable like the S&P would be meaningful, but this is not the S&P.”

Strongly bullish

“If you’re going to take on that much risk, you want the ability to participate. The 1.2 times leverage is nice but not huge, particularly with this low cap,” he said.

“If you’re going to buy into this index, you must be optimistic about this asset class and look for a rally.

“I’d rather have the opportunity for a big bounce than having 15% downside protection, especially given the fact that 15% doesn’t really help anyway.

“If I really liked this asset class, I would want to have unlimited upside. I would probably find it more attractive to buy the ETF directly. At least with the ETF, if the fund is down at the end of the 14 months, it’s not the end of it. I can stay in it and recoup the loss. With the note, I’m out.”

View, potential

Foldes ’criticism of the structure is based on the idea that investors’ expectations cannot be met by the terms of the product.

“The view of this note is inconsistent with the note itself,” he said.

“There is a contradiction between the manufacturing of this note and who they’re targeting this note to.

“If you’re in this trade, it’s because you want the high upside. It’s a beaten-down sector. Somebody willing to invest in this kind of note would be quite aggressive. But the note itself doesn’t reflect that. Your upside is modest, and your downside protection is very weak.”

J.P. Morgan Securities LLC is the agent.

The notes (Cusip: 48128GAT7) priced on Oct. 21.

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