Bank of Montreal's notes with lookback linked to S&P 500 target 'barely bullish' investors

By Emma Trincal

New York, Feb. 4 - Bank of Montreal's 0% bullish enhanced return notes due Feb. 28, 2017 linked to the S&P 500 index offer an attractive lookback feature, but sources said that the low cap and absence of downside protection may offset some of the lookback benefits, especially if the market moves wider than the flattish outlook implied by the structure.

The initial index level will be the lowest closing level of the index during the period that begins on the pricing date and ends one month later, according to a 424B2 filing with the Securities and Exchange Commission.

If the index return is positive, the payout at maturity will be par plus 200% of the increase, subject to a maximum return of 30%. If the index return is negative, investors will have 1-to-1 exposure to the decline.

Cap

Tom Balcom, founder of 1650 Wealth Management, emphasized the low cap.

"You're losing 2% a year in dividends. That's true of most structured notes, but your annualized compounded maximum return is 9.14%. Since this is your cap after leverage, you're expecting less than 5% a year in return," he said.

"It's obviously not for the bullish investor since the cap limits your upside. It would be more geared toward someone who wants to go in equities and who anticipates that the market is going to be lower before it gets higher.

"The only way you can outperform the index is if the index return is very low. With the leverage, your low-single-digit annual return will translate into a higher performance than the index. That's the expectation: a very modest growth in the index and no downside, which give investors the opportunity to outperform a long-only exposure to the index."

Donald McCoy, financial adviser at Planners Financial Services, agreed.

"If you're bullish, you're cutting yourself off the additional upside. It's more appropriately designed for a moderately bullish investor," he said.

No buffer

What complicates the outlook, Balcom said, is that the market view implied in the notes rules out any market losses at maturity while anticipating a sluggish index appreciation.

"You can't be bearish because there is no buffer there," Balcom said.

"For investors concerned about a possible pullback any time in the next three years, this note wouldn't make sense.

"It would be better for clients who want to put cash to work and who anticipate that the market could go lower while finishing up."

That's when the lookback feature may help, he noted.

"It gives them an opportunity to buy at a lower price, which can be attractive, especially if the market continues to be volatile, as it has been recently," he said.

Lookback

The leverage remains the main appeal of the product, but only if market gains are subdued, said McCoy.

"The product is aimed at people who think that the market is mostly played out but don't anticipate a prolonged downside risk to the market. If the index increases a little bit over the next three years, you're going to magnify your participation to that two times," McCoy said.

The lookback is a "unique" feature, he added.

"On a market like the one we're currently experiencing, it may come up to be particularly handy," he said.

"Unfortunately, the lookback, in order to work requires the market to drop early on in the life of the notes, which is difficult to predict.

"And even if the market dropped significantly in the first month - and that would be the desired outcome - the cap could easily offset the benefit of the lookback.

"If you have an early sell-off, it's likely that three years later, the market will be up and up by more than 15%.

"Because of the leverage, you're only talking about a 15% cap over three years. The more the market drops early, the more likely you are to max out at maturity.

"So even though the lookback is beneficial, the cap may offset the benefit, especially a low cap like this one."

A matter of perspective

There are no bad structured notes, said Balcom.

"Every note is good as long as it meets your market view," he said.

"The viewpoint on this one has to be moderate returns with the anticipation of a market sell-off early on. That way, the investor can purchase the index at a lower price."

However, Balcom said he would not consider the investment.

"My outlook is different. On a three-year horizon, I'm more optimistic. I'd rather have a long exposure to the index directly and not forego dividends. But it doesn't mean it's a bad note. It just doesn't fit my market outlook," he said.

McCoy wondered if the note could appeal to a great number of investors.

"This product would have to be geared toward people who are not concerned about the downside risk while expecting very mediocre results from the market. There may be a significant number of people who would expect a zero to 15% growth in the S&P 500 over three years with no decline. I'm not sure," he said.

"You would have to expect turbulence in the market without the market dropping significantly, if at all.

"If you're bullish, you're probably better off with another product. This is for an investor who is barely bullish."

BMO Capital Markets Corp. is the agent.

The notes are expected to price Feb. 26 and settle Feb. 28.

The Cusip number is 06366RSZ9.

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