Citigroup's dual directional notes tied to S&P 500 deliver meager return given market moves

By Emma Trincal

New York, Dec. 3 - Despite the absolute return feature, buysiders said that Citigroup Funding Inc.'s 0% dual directional trigger Performance Leveraged Upside Securities due June 22, 2015 linked to the S&P 500 index failed to deliver enough upside given the range bound market assumption of the trade.

If the index finishes at or above the initial index level, the payout at maturity will be par of $10 plus 150% of any index gain, up to a maximum return of 21.5% to 24.5%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index falls but finishes at or above the 80% trigger level, the payout will be par plus the absolute value of the index return.

Otherwise, investors will be fully exposed to losses.

The 21.5% to 24.5% cap over the two-and-a-half-year period is the equivalent of 8.6% to 9.8% per year, sources noted. Assuming a 9% annual return, it would only take a 6% rate of return per annum for the index to enable investors to hit the cap given the leverage factor of one-and-a-half times, they noted.

On the other hand, investors can lose their entire investment if the index is less than the 80% trigger as there is no minimum payment at maturity, according to the prospectus.

Wasted returns

Jim Delaney, portfolio manager at Market Strategies Mgmt., looked at recent price moves in the S&P 500 over the two-and-a-half-year period and concluded that investors in the notes would be taking on too much upside risk.

From May 2, 2011 to Sept. 30, 2011, the S&P 500 lost 22%, he noted.

From Oct. 4, 2011 to March 30, 2012, the index rose by 31.88%.

"If we go from June 30, 2010 to today, roughly the two-and-a-half period, the S&P shows an annualized rate of return of 18%," Delaney said.

"This is just an illustration of the big moves that we can see. We're not even talking leverage here. If it only takes 6% to achieve 9%, and the S&P can be up at a rate of 18% per year, that's a third of that. If you buy those notes, you're wasting two-thirds of the potential performance of the S&P.

"In two-and-a-half years from now, the fiscal cliff will be out of the way, Europe will get its act together and China's stimulus should continue to support economic growth.

"If the nearer past is any kind of indication, you're going to give up a lot of performance if you buy this piece of paper," said Delaney.

Even if the recent S&P performance was much less, investors would still be missing out on a lot of the upside, he said.

"Say for instance that the S&P is up approximately 8.5% a year. With the leverage, that's more than 12% a year while you get at the most 9% with the notes. You're still wasting a lot."

Delaney said that he did not necessarily talk from a bullish perspective.

"I'm just looking at a chart that has a number of big moves and that has gone from the lower left to the upper right. We've had a couple of corrections already. Two years and a half from now is a long time. It's sufficiently long to expect better returns than what this cap can offer," he said.

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said that the risk reward profile was not attractive but his focus was on the downside risk rather than on the limited upside.

"I like the leverage factor but the cap is kind of a bare minimum," Kalscheur said.

"True it's on the S&P. If it was on the Russell, a much more volatile index, I would want the cap to be much higher.

"But still. For the S&P 500, my rule of thumb is usually 10% a year. It's close enough, maybe but I'm not really excited about it.

"However the limited upside is not necessarily the deal breaker for me. The upside is low, but that's not why I wouldn't buy it.

"The real reason is this absolute return cliff," he said.

Dangerous cliff

Kalscheur said that investors in the notes would have to assume that the market would trade in a range. The problem, he added, was that such a range would be too narrow in his view to make this product competitive with other notes on a two-and-a-half-year term.

"You'd have to expect that the market will return something between positive 15% and negative 20%. It's a pretty narrow window to hit," he said.

"I just can't get excited about the probabilities of this note being the best performing product for that type of period under the circumstances.

"We see autocallables that return probably that much on an annualized basis and they're shorter and somewhat less risky.

"In a very good market, this product would not work because of the cap. In a mediocre market, it would perform in line with other products out there. And in a down market, you would have other structured notes out there that would compete better because they would give you a buffer or something.

"You would need the market to return in the low single-digits to low negative-single-digits for this to be the best product. It's a very limited scenario. Even though I agree that you're losing a lot of the potential upside with this note, the real problem for me is the cliff."

He gave the example of two very close performance scenarios leading to very different results. For instance, if the index closed down 20%, investors would generate a 20% gain, based on the absolute return feature. On the other hand, a 21% decline in the S&P 500 would trigger a 21% loss for the investor.

"I can't in good conscience as a planner recommend this to a client because I wouldn't be doing my job of reducing risk. How do you tell a client that you're up 20% and the next day down 21%? The hedge guys can hedge away that risk but I can't do that with my clients.

"The absolute return sounds good at first but it's only better than everything else under very limited circumstances.

"It reminds me of some insurance products that come very cheap. But it's cheap for a reason. It's because it doesn't pay. I get the same uneasy feeling with this cliff.

"If it's good, it can be really, really good, but if it's bad, it's really, really bad," he said.

Citigroup Global Markets Inc. is the underwriter.

The notes will price on Dec. 17 and settle three days later.

The Cusip number is 17318Q368.

© 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.