JPMorgan’s rare six-month leveraged notes on S&P may outperform the market, advisers say

By Emma Trincal

New York, Aug. 12 – Investors are used to short maturities with autocallable products, which account for 60% of U.S. structured products sales. But when it comes to leverage, the shortest maturity tends to be 14 months and often run much longer, sometimes up to five or six years. JPMorgan Chase Financial Co. LLC’s 0% capped buffered return enhanced notes due Feb. 24, 2022 linked to the S&P 500 index is an exception.

If the index return is positive, the payout at maturity will be par plus 1.5 times the gain, capped at par plus 6.35%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index declines by up to 5%, the payout will be par. Investors will lose 1% for each 1% decline beyond 5%.

Too soon for a trend

This is the first six-month leveraged note to price this year and only the second one with a tenor under one year, according to data compiled by Prospect News.

The second shortest deal came from GS Finance Corp. in July. It was a $10.37 million issue of 5½ year leveraged notes tied to an equity basket (ETFs and indexes) leveraging up the upside two times up to a 5.8% cap. Morgan Stanley was the agent.

Sideways view

“I’ve seen very few six-month leveraged notes,” said Steve Doucette, financial adviser at Proctor Financial.

“If you’re assuming that the market is going to be range bound, these terms have some merit.”

Doucette liked the note because it allows investors to beat the market under certain scenarios.

“It’s only a 5% buffer but it’s a six-month note. A buffer is a buffer,” he said.

“The 6.35% cap is a 13% per year. That’s not a bad return.

“If it’s up, you collect the cap easily.

“If it’s down, even down a lot, you’ll still outperform the market because you have a 5% buffer.

“As long as you don’t expect to make much more than the cap on the upside it’s a nice play.”

For comparison’s sake

This leveraged structure is so short in duration, it might be tempting to compare its return to that of an autocall.

“The return on this one this looks much higher. But autocalls and leverage notes are different structures designed to accomplish very different things,” he said.

Still the divergence of returns between this short-term enhanced return note and some autocalls, which can have similar durations and short tenors, cannot be ignored.

There aren’t many recent examples of autocallable contingent coupon notes on the S&P 500 index given how difficult pricing short-volatility products has become in today’s bull market.

A recent example however showed a Citigroup Global Markets Holdings Inc.’s $3.91 million issue of two-year callable securities on the S&P 500 index paying a quarterly contingent coupon of 5.1% per year based on a 75% coupon barrier identical to the barrier at maturity.

Back in July, UBS AG, London Branch priced a small deal of one-year callable notes on the S&P 500 index paying a quarterly contingent coupon of 3% a year. The barrier levels were at 70% for the coupon and 70% at maturity.

The barrier factor

For Doucette, there was no point in comparing the upcoming JPMorgan deal with recently priced autocalls.

“These are different animals,” he said.

“With these autocalls, you can capture your coupon on the downside. I see them as fixed-income replacements.”

“Sometimes, you get 55% barriers. The lower the barrier, the lower the yield. You almost have to be bearish.

“A smart adviser would look at it as a hedge, nothing more.

“I would never do a 3% coupon unless I believed the market would drop.

“This one, with the leverage, is equity. It’s an equity play assuming the market is range bound.”

Do it yourself

Doucette admitted that coupons have dropped on income notes. While he would rule out buying notes bearing 3% or 5% coupons, he said he is still in the market for snowballs.

“I could certainly look at a memory coupon on a longer term. The market is changing. You have to adjust the parameters especially as the market is at all-time highs.

“This leveraged one is kind of neat. You most certainly can get the cap, and that’s a nice return,” he said.

One downside to the short duration was the tax treatment. The prospectus warned that investors are likely to be subject to short-term capital gains since the maturity is under one year.

“We always try to think of the tax liabilities. But if you have a product that can outperform the market, the tax treatment is secondary,” he said.

Special situation

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he liked the notes as well.

“It’s not very common to see a leveraged note with such a short term,” he said.

“It looks like a structure built for a particular investor who has a mandate to hold the S&P for that maturity.

“It could very well be an institution. It has the feel of a specific situation.”

The fee for the notes is only 0.1%. Institutional investors tend to negotiate lower fees, he noted.

Buffer, tenor

Some investors consider a 5% buffer as a disappointing level of protection. But it was not the case with Medeiros.

“You’re just having a minimal protection. It does nothing if the index goes down 30%. But it surely feels good if it drops 10%.

“It’s nice to have a little bit of a buffer on such a short period of time. It’s better than nothing.”

While this adviser liked the terms of the note, the tenor would not meet his investment requirements.

“It’s just not something that we do. We’re not short-term investors,” he said.

“But I can see an institution having a mandate for this kind of product.”

Excess return

One of the advantages of the note was its ability to outperform the S&P 500.

“It’s hard to predict what the market will be like in six months. You run into the issue of risk over a short period of time.

“But I like the leverage. Even if the index is up 2%, you get 3%.

“The 6.35% cap is attractively priced for a six-month term.

“Overall, you can beat the S&P on the upside and on the downside.

“I like it,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes are expected to settle on Aug. 13.

The Cusip number is 48132WBU2.

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