JPMorgan’s capped leveraged notes on Russell aimed at neutral, mildly bearish investors

By Emma Trincal

New York, Jan. 27 – JPMorgan Chase Financial Co. LLC’s price 0% capped contingent buffered return enhanced notes due Feb. 1, 2023 linked to the Russell 2000 index are designed for investors expecting very low returns in the underlying given the cap, sources said. The downside protection can also be used as a hedge, one of them noted.

The payout at maturity will be par plus 3 times any gain in the index, capped at par plus 22.15%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 25% and will be fully exposed to the decline in the index if it falls by more than 25%.

Carl Kunhardt, wealth adviser at Quest Capital Management, said the notes would fit his outlook as his return expectations for the U.S. equity markets as a whole are moderate.

Small cap

“The cap is small, at less than 7%, especially for small-caps. The only weakness in this note is that you’re not setting a very high bar,” he said.

“But we’re 11 years into a bull market and it’s an asset class you’re going to have in your portfolio anyway if you’re an asset allocator.

“I might do it just for the protection.”

For the three-year timeframe, a 3x leveraged upside capped at 22.15% represents an annual cap of 6.90% on a compounded basis. Such gain could be achieved with a very small return of 2.4% a year.

Leverage, barrier

“We’re going to have some type of correction in the next three years,” said Kunhardt.

“Nobody expects it this year. Now the consensus is that we could have one in 2021. If that’s the case, we should have a recovery by then.

“But if we have a 10% or 20% pullback in 2021, you may not reach an annualized 7% on the third year.

“This is why the leverage is helpful.”

For the downside, a 25% buffer would have been better, he said. But Kunhardt still liked the 75% barrier.

“It’s a hedge. You have some protection,” he said.

Kunhardt’s market predictions are based on advisory firm Mercer, which projects for the Russell 2000 index an annual rate of return between 8% and 9.5% for the next five and 10 years.

“We’re not too far off and we have the hedge on the downside,” he said.

Credit, fee

Steve Foldes, vice-chairman at Evensky & Katz / Foldes Financial Wealth Management, has a more bullish outlook and therefore could not use the notes.

He first reviewed the credit of the issuer and the 2.75% fee, whose amount was disclosed in the prospectus.

“JPMorgan has a wonderful, strong credit. No issues there,” he said.

“The 2.75% fee strikes me as pretty high though.”

He then commented on the market view embedded in the structure, which he said was anything but bullish.

Neutral outlook

“This is a note for somebody who is either neutral or mildly bearish on the small-cap market,” he said.

“Historically, the Russell 2000 has outperformed the S&P 500.

“So you’re giving up not only a 1.25% dividend on the Russell but also any gain above 7% when the historical average for this index is 11%.

“You have to be quite bearish.”

In the same way, the amount of downside protection probably exceeded what a bullish investor would need.

Missing out a lot

“Over a three-year period, it’s very unusual to have an index down 25%, so the barrier is probably overkill unless you are pretty bearish, which is the nature of those notes,” he said.

Another reason to pass on the note was the value proposition offered by the Russell 2000 index. While historically the small-cap benchmark has generated better returns than the S&P 500, in recent years, its performance has been lagging the S&P, making small-caps a good choice for value-oriented investors compared to the high valuations of the large-cap market, he noted.

“The Russell has underperformed the S&P 500 over the last three years. You have to go back to 2016 to find a year when the Russell has outperformed large-caps,” he said.

Three bad years

In 2019, the S&P 500 index outperformed the Russell 2000 by 5.16 percentage points.

In 2018, the U.S. markets were down but the Russell 2000 fell by 12.18%, a deeper drop than the 6.24% decline posted by the S&P 500 index.

In 2017, both benchmarks were up. Yet the S&P outpaced the Russell by 6.28 percentage points.

It’s only in 2016 when the Russell 2000 returned 19.48% that it outperformed the large-cap index.

The gap was nearly 10 percentage points over the S&P, up 9.54%.

No cap for bulls

“You have a very low cap on an index that has historically outpaced the S&P and you are making that investment after the Russell underperformed the S&P for the past three years,” he said.

“It would not be suitable for us. We are bullish, and as a result, we wouldn’t want a cap.

“This is a way to protect the downside if you are neutral to mildly bearish on the market because of the low cap and the 25% barrier.

“But if you are bullish or even mildly bullish you wouldn’t want a cap of less than 7% a year.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes will settle on Thursday.

The Cusip number is 48132HVD1.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.