JPMorgan’s digitals on Russell, S&P offer choices to asset allocators, advisers say

By Emma Trincal

New York, Aug. 30 – JPMorgan Chase Financial Co. LLC’s 0% digital barrier notes due Aug. 29, 2025 linked to the lesser performing of the Russell 2000 index and S&P 500 index offer the perspective of a target return with limited downside risk, which gives asset allocators a number of options to position the securities in the portfolio, advisers said.

If the worst performing index ends above its 60% barrier, the payout at maturity will be par plus 25%, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, investors will lose 1% for every 1% that the worst performing index declines from its initial level.

Bond replacement

Tom Balcom, founder of 1650 Wealth Management, leaned toward allocating the notes to the fixed-income part of his portfolio.

“You can use it as a high-yield play or fixed-income because of the deep barrier,” he said.

“The 7.7% annualized compounded return will beat most bond yields.”

Where to allocate the note depends on investors’ risk perception, he said.

“Is there a high likelihood that one of those two indices could be 40% lower than they are today three years from now? If the answer is no, you can probably use the notes as a fixed-income substitute. I would,” he said.

Another risk mitigation factor could be found in the timing of the trade.

The notes priced on Friday when the U.S. equity markets plunged in reaction to a hawkish message from Federal Reserve chair Jerome Powell in Jackson Hole.

The small-cap index dropped 3.3% on the day and the S&P 500 index shed 3%.

Bullet

Balcom compared the digital product with some autocallable contingent coupon notes.

“Your 7.7% return may be higher than some of those Phoenix autocalls, even with those tied to three indexes,” he said.

“That’s perhaps because you don’t have the call here. You’re not going to receive any income for three years. You get paid a premium to wait,” he said.

This could be an issue for the pure income investor, he said.

“But it’s still fixed-income. I like the concept of this note. I like the deep barrier. It really reduces the odds of a loss of principal,” he said.

Not an equity play

Balcom said he would not use the notes in his core equity allocation.

“It’s a target return. So, you’re capped at a 25% return over three years.

“Most folks would think that it’s too low for an equity return. People anticipate a market rebound over the next three years.

“We had a significant pullback. The stock prices are still falling.”

On Tuesday, the S&P 500 closed 1.1% lower and the Russell dropped 1.45%.

“Three years gives the market enough time to recover. Most people are bullish over that timeframe. They wouldn’t want the cap,” he said.

Hedge bucket

The notes could easily be used in the alternative investment part of the portfolio, he said.

“If you’re bearish on equity, you could really outperform. If the market is down 40%, you make 25%. You’re a hero,” he said.

The notes could generate alpha for the portfolio, he added.

“It’s a good fit into a hedge bucket if you don’t want to put it in your core fixed-income portfolio.”

Bearish notes

A financial adviser said the notes are best designed for bears.

“I can see the huge benefit if you’re bearish. The good thing with a digital is that if you’re expecting the next three years to be bad, you’re still going to make money. You have a chance to be up when the market is down especially if you can be down as much as 40%,” he said.

“That’s a really low barrier to the point that you’re almost taking no risk even with the worst-of.”

At the same time, the “pessimistic bias” of the investment limited the upside to the point of making the product inadequate for the equity portion of the portfolio, he added.

Deep barrier, low cap

“My rule is that when you’re exposed to equity risk, you should get equity-like returns, which I see as 10% or more. This breaks the rule. It doesn’t work,” he said.

As an equity replacement, the view would have to be strictly bearish.

“If you think the market is going to produce zero or negative returns over the next three years, then you can definitely outperform. You can get 25% if the market is down 40%. But you also get 25% if the market is up 50%.

This adviser explained from a probability standpoint why he wouldn’t use the product as an equity substitute.

“This is one of those catch-22 where the likelihood of getting 25% is pretty high. But the likelihood of the market being up significantly more than 25% is high too,” he said.

“That’s the tradeoff.”

He said that an investor may have a 95% chance of getting at least 25% but also a high probability for a 40% or 50% return.

“You’ll be stuck with 25%. You can’t really use it as equity because you’re giving up a lot of the upside.

“You have a solid protection. But you always pay for protection,” he said.

Process of elimination

He explained why the notes would not fit in the bond category either.

“It’s tempting to put it in the fixed-income bucket. It acts like a zero. It has an attractive yield compared to a bond. A corporate bond would give you much less... something like 4%, maybe 4.5%.

“Here you probably have a 90% chance of getting 7.7%. You may consider putting it in your bond bucket.

“But I wouldn’t. The barrier leads you to believe that your return is insulated from the stock market, but you’re not insulated from the stock market. Your return is based on the stock market,” he said.

As a way to navigate a down market, the notes would be best positioned in the alternative investment part of the portfolio, as a hedge, he said.

“This is a unique payoff with a conservative barrier and a chance to really outperform in a down market.

“It’s neither equity, fixed-income or cash. To me, it falls under the category of alternative investment,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes were expected to price on Aug. 26 and to settle on Aug. 31.

The Cusip number is 48133MSD3.

The fee is 0.95%.

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