Advisers ready to lower cap on JPMorgan’s buffered equity notes tied to Russell, S&P

By Emma Trincal

New York, Sept. 12 – JPMorgan Chase Financial Co. LLC’s 0% capped buffered equity notes due Sept. 16, 2021 linked to the lesser performing of the Russell 2000 index and the S&P 500 index resemble an offering this issuer priced two weeks ago on a much shorter term, which changes the entire profile of the investment and the trade-off, advisers who saw the previous deal told Prospect News.

With the new and shorter deal, they both were willing to lower the cap in order to mitigate some of the risk.

If each underlying index finishes above its initial level, the payout at maturity will be par plus the gain of the worse performing asset, capped at par plus 57.5%, according to a 424B2 filing with the Securities and Exchange Commission.

If either asset falls by up to its 20% buffer, the payout will be par.

Otherwise, investors will lose 1% for each 1% decline of the worse performing index beyond the buffer.

Two JPMorgan deals

The previous deal, on which these advisers commented last week, was different in significant ways: first, it was a five-year, not a two-year. Second, it offered an absolute return with a 50% participation rate rather than none.

Finally, the upside was uncapped, while this one is.

Everything else was nearly the same from a 20% buffer to the worst-of payout on the S&P 500 index and the Russell 2000. The previous deal was only slightly levered at a rate of 1.04 making it close enough to the one-to-one exposure of the second one.

Different trade-off

But once the maturity changes, everything is different, said Steve Doucette, financial adviser at Proctor Financial.

“You’re basically giving up the absolute return for a shorter duration. It’s a different trade-off...different deal,” he said.

Doucette examined the cap and concluded that its inclusion in the structure did not mean much.

“A 57.5% cap on a two year is not really relevant. Nobody is going to complain about getting 29% a year,” he said.

In both deals, but especially on the shorter-dated one, Doucette was happy with the 20% buffer as it allowed investors to outperform on the downside.

Absolute return vs. leverage

“The only problem is that you no longer get the absolute return. And over two years, your chances of having a bear market are much greater...and then, there isn’t enough time to recover,” he noted.

“The average bear market is two years. You don’t really need the absolute return on a five-year. But you definitely do on a two-year.”

When he commented on the previous deal last week, Doucette said he would rather see more leverage even at the cost of agreeing to a smaller buffer.

“On a five-year, the market can go down and come back up again. The protection isn’t that important.”

For that reason, the priority on the shorter-dated note was the absolute return rather than the leverage, the exact opposite of what was required to “improve” the five-year structure, he said.

“On a five-year, I prefer the leverage. On a two-year, I want the absolute return so I can outperform if we have a pullback.”

Capping down

To maintain the absolute return with the 20% buffer, Doucette said he would manipulate the cap.

“I can give up some of the cap. I’m not expecting 29% a year for the next two years,” he said.

“It’s probably not enough so maybe I could go for a lower rate of absolute return...even less than 50%. Why not a 25% absolute return?

“I’d rather have some protection and be able to beat the market on the downside. The rest is not all that important to me.”

Jeff Pietsch, head of capital markets at the Institute for Wealth Management, said the offering may fit with a defensive approach so long as investors understood the ramifications of a worst-of.

The “high” cap appeared to be the natural piece to play with in order to change the payout.

“This cap is almost meaningless. You wonder why it’s even there,” he said.

“If I had to choose, I’d rather see some reasonable cap that fits in my capital markets expectations rather than the worst-of component,” he said.

Two different beta

However, Pietsch said the notes could be useful for the more risk-averse investor given the sizable buffer.

“Investors just need to understand the exposure to the worst-performing index.

The Russell has a 1.22 beta, he explained, making the value of the buffer somewhat relative.

“If we have a 20% move to the downside in this vehicle, it would be the equivalent of a 16% drop in the S&P.”

If the market continued to be bullish, investors would likely be exposed to the S&P 500 index as the Russell would outperform, he added.

This adviser did not predict which of the two indexes would underperform. But both have high valuations, he said. As a result, investors in U.S. stocks should be prepared for a pullback.

Worst-of expectations

“In a bear market, you would get exposed to the Russell index, which is much more volatile. So you really need to understand the exposure,” the adviser said.

Unfortunately, modeling worst-of exposure is challenging.

“It’s hard to predict because you are considering the relative value of two benchmarks.

“A complicating factor is the interest-rate sensitivity. How will interest rates impact relative valuations between large-caps and small-caps in terms of access to debt capabilities?”

Overall, Pietsch said the notes could be used in a moderate-risk portfolio.

“If you understand the worst-of component, if seems like a reasonably priced, reasonably short-term note.

“If we have a pullback, it’s not a bad offering.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes will settle on Tuesday.

The Cusip number is 48132FLH7.

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