BMO’s $19.13 million buffer enhanced return notes on index basket offer global equity play

By Emma Trincal

New York, Sept. 14 – Bank of Montreal’s $19.13 million of 0% buffer enhanced return notes due Nov. 4, 2025 linked to a basket of indexes provide global equity exposure with equal weights between U.S. and international markets, according to a 424B2 filing with the Securities and Exchange Commission.

The basket consists of the S&P 500 index with a 50% weight, the MSCI EAFE index with a 30% weight and the MSCI Emerging Markets index with a 20% weight.

The payout at maturity will be par plus 200% of any gain of the basket, subject to a maximum return of par plus 28.75%.

Investors will receive par if the basket falls by up to 15% and will lose 1% for every 1% decline of the basket beyond 15%.

Default risk

“I don’t love the note. First, it’s too short. But mostly it’s because I can get the same return using a UIT or a buffer ETF without the counterparty risk,” said Julian Rubinstein, chief executive officer of American Asset Management.

He was referring to structured products, which are using 1940 Act wrappers, such as Unit Investment Trusts and ETFs. Those securities also generate returns derived from an equity underlying with defined outcomes. But as exchange-traded products, they provide daily liquidity. They also remove the credit risk exposure associated with bank-issued notes.

Substitutes

“We don’t use notes for growth products since it can very easily be duplicated with a buffer ETF or UIT,” he said.

He mentioned First Trust as a top provider of structured UITs and Innovator as the pioneer in buffer ETFs.

“Innovator has very liquid, very transparent products, which eliminate the counterparty risk exposure. One downside though is they’re very short term.”

Innovator Capital Management is an ETF issuer, which has created defined outcome ETFs providing leverage and buffers based on the performance of underlying indexes.

“This note doesn’t compensate me enough for the counterparty risk I’m taking. I can duplicate that outcome elsewhere,” he said.

Focus on income

This adviser manages a portfolio of structured products, which represents 18% of his assets under management with a 25% target.

“Most advisers use structured notes for 5% to 8% of their assets. For them, credit risk is not a huge risk since their notes are not a significant part of their practice,” he said.

Rubinstein does not rule out structured notes altogether.

“We do structured notes for income. And that’s because you can’t easily replicate those products with UITs or ETFs, at least not yet.”

Income-oriented notes, which are essentially callable securities, go into his income allocation.

“For my income bucket, I use worst-of notes with three indices, excluding the Nasdaq. But indices don’t generate very high returns because the risk is lower. So, we also like to use worst-of with stocks, usually three stocks. We look for memory and 50% barriers,” he said.

Diversified underlying

Matt Medeiros, chief executive officer of the Institute for Wealth Management, said he liked the BMO offering.

“It’s a plain-vanilla note. I like the terms,” he said.

“It could be a cornerstone or foundation holding in a portfolio providing diversification with downside protection.”

He said that the weighted basket should significantly reduce the risk compared to other payoffs.

“You’re not exposed to the return of each index like in a worst-of, but to the basket directly,” he said.

A negative performance from one of the basket components could be offset by the positive return of another, especially with the diversification across three distinct asset classes.

The equal weight between U.S. markets and international equities was another advantage, he noted.

Buffer, cap

Given the nature of the underlying, the notes offered adequate protection, he added.

“15% is a good size for a buffer especially one without any gearing. I think it’s very decent,” he said.

From a structuring standpoint, the size of the buffer was “fair.”

“It would be pretty tough to get much more than 15% on a 26-month note. So, I’m fine with the buffer. It’s in line with the tenor,” he said.

Typically, Medeiros is relatively cautious with short-dated notes but not so much in this case.

The diversified underlying along with the risk-adjusted return of the security gave him some confidence in the note.

On the upside, the 28.75% maximum return for the period represented a 12.4% annualized return on a compounded basis.

“I think it’s a very good cap relative to the underlying, which is not hugely volatile.

“You’re not getting a haircut on either side. The buffer is not too small. The cap is not too low.

“It’s a pretty good note,” he said.

BMO Capital Markets Corp. is the underwriter.

The notes settled on Tuesday.

The Cusip number is 06375MBK0.

The fee is 0.21%.

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