Citigroup's trigger performance notes linked to S&P 500 offer market exposure with protection

By Emma Trincal

New York, Aug. 6 - Citigroup Inc.'s 0% trigger performance securities due Aug. 31, 2018 linked to the S&P 500 index are designed for skittish investors who want to get exposure to the U.S. equity benchmark while limiting their potential losses as much as possible, sources said.

"The structure is more geared toward downside protection than aggressive growth," said Tom Balcom, founder of 1650 Wealth Management, commenting on the trigger level and the low upside leverage factor.

The payout at maturity will be par of $10 plus 110% to 120% of any index gain, with the exact participation rate to be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 40% and will be fully exposed to the losses if the index finishes below the 60% trigger level.

Geared toward protection

For Balcom, the return enhancement was limited in scope with the emphasis of the structure on the downside.

"There's a bit of leverage to compensate the investor for giving up the dividends. But that's not why you would buy the notes," he said.

"This product is for people who want exposure to the benchmark but who are also nervous about the market over the next five years. You have to be bullish or moderately bullish. If the market is flat, you'll be all right. You can't be too bearish because you have to believe that the S&P won't drop by more than 40% five years from now.

"This note could accommodate a number of different views from bullish long-term to short-term bearish.

"There is a lot of concern right now about how much U.S. stocks have advanced so far. We've reached new highs, and the market is still very strong."

The S&P 500 is up 19% year to date. In July alone, the index rose 4.4%.

"Some investors worry about buying at those levels. They may believe that we'll get a pullback in the next five years followed by a bounce back. If that's the view, the 40% downside protection could be helpful. At least, they won't have to worry about the downside," he said.

Even if the 40% soft buffer appeared to be generous to investors, the nature of the protection had to be evaluated with caution, he noted.

If the index finishes lower than the trigger level, investors may lose their entire principal, according to the risk section of the prospectus.

"This 60% trigger level is the equivalent of selling a put option for 40%. The risk is that the market would go down 41%. Investors in the product can anticipate a downside, but they have to be pretty optimistic and believe that the market won't go down by more than 40%," Balcom said.

Overbought index

Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments LLC, said that the features of the structure - long exposure to the index and downside protection - could be easily replicated with other securities at a cheaper cost.

"If you're interested in maintaining your principal, you can find investments that would do just that. And if you want exposure to the S&P 500, there are very cheap ways of doing that too," he said.

The notes are not designed for access, he noted.

"This kind of structure is not tied to an exotic security. It's the S&P 500. It's very simple to come up with equivalent products that have a zero percent fee to achieve the same goal instead of being locked up for five years."

Part of Kaplan's objection to the notes' underlying investment theme was the idea of initiating a long position for five years in an index that many in the market consider to be overbought and overpriced.

"I want to be able to sell when the S&P is high, as it is right now, and to buy when it's low. You can't really do that with this type of investment," he said.

"The S&P 500 having more than doubled could easily fall by half over the next five years."

The structure of the notes enabled investors to combine two features - exposure to the S&P 500 and a 40% soft protection.

Both "legs" of the trade could be easily replicated with other instruments, he said.

For the return of principal feature, he suggested buying a zero-coupon bond.

"You could buy a five-year Treasury bond. It's best when interest rates are high, but you would buy it for safety, not for the yield, knowing that the U.S. government is not going to default. So that would take care of the principal-protection component," he said.

Contrarian views

The other "leg" - which consisted of buying the S&P 500 trading at an all-time-high - was not advisable at this point, Kaplan said.

"You'd [be] better off waiting for a correction," he said.

"The best time to buy the S&P 500 was at the end of 2008, first half of 2009 or perhaps in October 2011, not now."

During a market downturn, Kaplan said that he would consider buying closed-end funds tracking the S&P 500 if his goal was to get exposure to the benchmark.

"Once you see a sell-off, people panic and you can begin to find closed-end funds that trade at huge discounts to NAV because people overreact and sell. You can get extraordinary bargains not just because the S&P is low but because the discount is much wider than normal," he said.

"Money is made on things that become unpopular. The S&P 500 is very popular right now. I wouldn't buy it now."

Kaplan said that he is focusing on other asset classes that have underperformed the S&P 500 and fallen out of favor.

"I am somewhat of a value investor but with a focus on market cycles," he said.

"I look for bargains. Now we have definitive undervaluation in commodities and emerging markets.

"Last year people didn't like European shares; now they do. This year it's emerging markets. The best time to buy something is last year.

"Instead of the S&P 500, I would be looking at commodities producers. They are at four-year lows. Emerging markets too are at four-year lows.

"Brazil, Russia, India haven't gone up in four years. I would tend to think it's rational to look at those markets at this point rather than buying the S&P."

Citigroup Global Markets Inc. is the agent.

The notes (Cusip: 173095167) will price Aug. 27 and settle Aug. 30.

The fee is 3.5%.

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