JPMorgan’s $1 million uncapped notes on indexes need tweaks on the downside, advisers say

By Emma Trincal

New York, April 17 – JPMorgan Chase Financial Co. LLC’s $1 million of 0% uncapped dual directional accelerated barrier notes due April 15, 2026 linked to the Dow Jones industrial average, the Nasdaq-100 index and the Russell 2000 index appeared to satisfy advisers for the upside payout, but they recommended some changes on the downside structure to adjust the terms to their respective market outlook.

If the worst performing index gains, the payout at maturity will be par plus 147.25% of the return of that index, according to a 424B2 filing with the Securities and Exchange Commission.

The payout will be par plus the absolute value of the worst performing index return if the worst performing index declines but finishes at or above the 70% barrier.

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

The good news

Steve Foldes, wealth manager and founder of Evensky & Katz / Foldes Financial Wealth Management pointed first to some of the positive aspects of the product.

“This note could have been more attractive with a few changes. There are things I like and things I don’t like about it,” he said.

The issuer was among the positive items.

“JPMorgan’s creditworthiness is terrific,” he said.

JPMorgan indeed has the tightest credit default swap rates among U.S. large banks, according to S&P Global Market Intelligence, which means that the cost of insuring the bank against default is among the cheapest.

The bank’s five-year CDS spreads of 71 basis points compare favorably with the 84 bps spread for Citigroup, 87 bps for Morgan Stanley, 95 bps for Goldman Sachs and 100 bps for Bank of America, according to S&P.

The cost structure of the note was another advantageous feature.

“The 0.75% fee is reasonable. There is no issue there,” he said commenting on the fee amount disclosed in the prospectus.

“And of course, the leverage factor of almost 1.5x is nice.”

The bad news

On the “less attractive” side, Foldes pointed to the choice of the underlying indexes.

“Of course they’re all major U.S. indices, which is fine. But there are pretty significant gaps between the three of them. You have the potential for divergences,” he said.

The Dow for instance dropped less than 9% last year while the Nasdaq-100 lost a third of its value, he noted. Meanwhile the Russell 2000 index fell by nearly 22%.

“They may all move in the same direction but with significant gaps between one and another.

Foldes would select different underlying indexes.

“I’d like to see indices moving more closely in tandem. Also, I don’t love having three indices in a worst-of. I would limit it to two. Ideally, I would do away with the worst-of.”

Another drawback was the “loss” of dividends over the three-year period.

The highest dividend returns would come from the Dow, which yields 2.15%.

Because the opportunity cost induced by the non-distribution of dividends may be as high as 6% over the term of the notes, Foldes said having more leverage was a requisite.

“What makes the note very attractive is the fact that you have this 1.5x leverage with no cap, and this is key since we’re at very depressed levels,” he said.

Reshuffling the note

Increasing the leverage factor could be easily done through a few modifications of the downside payout, especially for the benefit of bullish investors whose view Foldes embraces.

“There are terms in this note that I don’t need, for instance the 70% barrier and the dual directional,” he said.

Current prices in the U.S. equity market remain low compared to where they used to be at the end of 2021 even if all three indexes have rebounded so far this year.

“We are starting at bargain levels. A barrier and the dual directional have a cost. I would do away with those two things to increase the leverage significantly,” he said.

Foldes was surprised by the small size of the deal.

“It’s a $1 million deal, which tells me that few advisers may have found the structure very compelling unless it was designed for one adviser,” he said.

Aggressive growth

Carl Kunhardt, wealth adviser at Quest Capital Management, said he would allocate the notes to a small portion of his portfolio.

“I might do it. And honestly, my motivation would be greed,” he said.

The underliers were not a major stumbling block.

“I’m not a fan of worst-of. However, those three indices have a positive correlation.

“On a big picture basis if you believe that the market will be better in three years, which I do, then it almost doesn’t matter which index is the worst-of. Your worst-of will be the lowest of a positive return and you get 1.5 times leverage on your upside,” he said.

But the downside payout could be ameliorated, he noted.

“I would prefer a buffer to a barrier. Obviously, you need a big barrier because the Nasdaq can breach easily,” he said.

“30% is not bad, but a buffer would be better.”

However, the downside structure was not a “deal-breaker” he said.

“You’re taking the full market cycle and we’re just starting the recovery phase. Even the laggard will be positive and with the 1.5 leverage factor you’ll still get into a return ostensibly greater than if we were holding the index long,” he said.

“I would use it as a small piece of my equity allocation. It would be part of my aggressive growth strategy.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes settled on Thursday.

The Cusip number is 48133VVT4.

The fee is 0.75%.

© 2015 Prospect News.
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