BofA’s capped Accelerated Return Notes tied to Russell 2000 need protection, buysiders say

By Emma Trincal

New York, June 14 – BofA Finance LLC’s 0% Accelerated Return Notes due August 2020 tied to the Russell 2000 index are designed for investors trying to boost returns in a slow market with a leverage multiple higher than usual.

While the return enhancement is appealing especially over the short investment timeframe, sources said the full exposure to a market decline is not ideal in today’s uncertain market environment.

The payout at maturity will be par plus triple any index gain, up to a capped return of 12% to 16%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will be exposed to any losses.

Sideways

Marc Gerstein, director of research at Chaikin Analytics, said he was cautious.

“I’m not sure I like this because there is no downside protection at all,” he said.

“The upside leverage is great but it’s a very narrow cap. I mean the range in which you can outperform the index is very narrow.”

On a 14-month note, a 12% cap would be the equivalent of a 10.2% annualized compounded return, which could be achieved if the index rose by only 3.4% a year.

“You really have to have this conviction that the index won’t go anywhere. It has to move up a little but it can’t go down. If it goes down, you’re losing money right away,” he said.

Better alternatives

Gerstein said a sideways view could be better expressed with different securities.

“There’s got to be some alternatives with options, something that adds a more defensive element to this strategy,” he said.

“You have many option trades available if you expect the market to be range bound.”

If the view was indeed range bound, profits should be generated on both sides of the market, he said, and not just if the underlying is modestly up as it is the case with the notes.

“What if it goes down even a little bit? You’re not hedged.

“If there was some downside protection, I might be interested.”

By design, the structure was created for moderately bullish investors who ruled out wide price moves both up and down.

“I guess the advantage is to have this 3-to-1 upside exposure for a 1-to-1 downside. But you’re paying for that as you’re getting nothing on the downside,” he said.

“I’d rather buy a 3x levered ETF and hedge the downside with puts or with a short position.

“I think it would create a better risk-reward balance.”

Setting priorities

A financial adviser had a similar view: the structure was not defensive enough given current market conditions.

“If you think the market is going to be slightly up, this is a good way to do this,” said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

“It doesn’t appeal to me because I’m looking for things that are risk-management-focused.

“I’m not trying to leverage my upside now. I’m trying to manage my risk.

“3x is great. It’s just not the right time to try and squeeze out the last nickel.

“This note is mainly about maximizing your upside. I’m more concerned about minimizing my risk exposure in this market.”

The note was not very bullish given how easy it is to be “capped out,” he added.

“The market really doesn’t have to be up all that much. Anything above 4% and you’re capped. Not sure it’s worth the risk of taking on the full downside.”

“If there was a buffer or a barrier, I would look at it in a very different way.”

Big tickets

Matt Rosenberg, sales trader at Halo Investing, however said there is a need for these kinds of structures, which tend to price in big block trades.

JPMorgan Chase Financial Co. LLC for instance sold $40.55 million of leveraged securities linked to the Euro Stoxx 50 index at the end of last month, with Morgan Stanley handling the distribution.

“If you have a core allocation to the index it may be very interesting to enhance the upside without taking any more risk than if you were long the index,” he said.

“You don’t have a strong bullish conviction but overall, you’re positive on the asset class. The 3x leverage allows you to cap out easily and you can do that in a relatively short period of time.”

The notes from BofA Finance are guaranteed by Bank of America Corp.

BofA Merrill Lynch is the agent.

The notes will price in June and settle in July.

© 2015 Prospect News.
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