Citigroup’s 21- to 24-month buffered notes linked to S&P 500 offer short-term, cautious play

By Emma Trincal

New York, Jan. 17 – The buffered protection and leverage of Citigroup Global Markets Holdings Inc.’s 0% 21- to 24-month buffered notes linked to the S&P 500 index may fit the needs of cautious short-term investors, but the capped return is likely to be unappealing for bulls, according to buysiders.

The notes will be guaranteed by Citigroup Inc.

If the index return is positive, the payout at maturity will be par plus 1.5 times the index gain, subject to a maximum return of 19.065% to 22.425%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index return is zero or negative but not less than negative 12.5%, the payout at maturity will be par.

If the index falls by more than 12.5%, investors will lose 1.1429% for every 1% decline beyond 12.5%.

Short

Jerry Verseput, president of Veripax Financial Management, said one of the main appeals of the notes is the short maturity.

“This is for people who are going to need the money in two years,” he said.

“If you have a longer timeframe than that, you can do a lot better. And that’s usually what I like ... to have a five- to six-year sweat spot ... so you can get more bang for your buck in terms of the cap and the downside protection.”

Verseput said he likes to extend maturities to get uncapped leveraged notes with reasonable downside protection features, something that is more challenging over a short term.

Investors in this note would want to get exposure without taking a lot of risk, he said.

“Don’t get me wrong. There is still a lot of risk. But the notes are appropriate for someone who wants to participate in the stock market over a short period of time with less risk because it’s still a buffer.”

Downside

He offered an example in which the market turns bearish and the S&P 500 is down 30% from its initial value at maturity. Investors long the index fund would lose 30% while noteholders would lose 20%, he said. Investors in the notes forgo a 2% dividend yield – an opportunity cost comprised between 3.5% and 4% depending on the tenor.

“You would always be better than the index on the downside because you’re not losing dividends for a very long time. The market would have to be ridiculously low for you to underperform,” he said.

“If the S&P is down 50%, you don’t care if you’re only down 40%.”

Specific view

On the other hand, investors are more likely to underperform on the upside.

“Imagine we have another 2013 with the index up 30%. I bet you would feel some regret,” he said.

But for some investors, the notes may be a “reasonable” option.

“It’s useful but useful only if you have a two-year timeframe and don’t want to be fully exposed to the market. In that case, the trade-off is to limit your upside, and it makes sense,” he said.

On the plus side

Steven Foldes, vice-chairman of Evensky & Katz/Foldes Financial Wealth Management, would not be interested in the notes because of the limited upside appreciation.

He stressed the positive aspects of the deal first.

“We like the length. Twenty one to 24-month is fine with us. Citi is a big bank. The institution is reasonably good, so we don’t have a huge problem with the credit. And finally, we like the 1.5 times leverage,” he said.

“But there are some things we do not like, which would preclude any interest in buying these notes.”

Low cap

Foldes usually looks for equity-linked notes that do not limit the upside. He likes to remain invested for less than two years, and if those terms have to be negotiated, he tends to make concessions on the downside depending on the underlying.

“If we’re going to get access to a growth asset class such as the S&P, we’re going to have full participation, meaning if the index is up, we’re not getting capped out,” he said.

Noting that “they’re playing” with a range for the disclosure of the cap and tenor, he assumed an annualized compounded cap of 9% to 10%.

It is a conservative assumption. Depending on how short the maturity is and how high the cap, the annualized compounded cap varies from 9.15% to 12.25% per year.

“A 9% to 10% cap on an equity asset class where I’m giving up a dividend of 2% seems to be a lousy deal,” he said.

“If you’re reasonably optimistic, you know you’re not getting a lot.”

Asked whether he is optimistic about the market, Foldes said he just does not like to limit his chances of getting as much return as the index, especially when structured note investors are not entitled to receive dividends.

Range-bound view

“The person buying this note would have to really believe that the markets are going to be extremely modest,” he said.

“It would only make sense if they see the market trading range bound with a potential negative return.

“I wouldn’t want to be pigeonholed in that structure.”

As an alternative, Foldes said he is very interested in digital notes that offer unlimited upside beyond the digital.

To get full upside participation over a short period of time, the condition is often to give up any downside protection. Such terms may be acceptable on some asset classes Foldes is really bullish on.

Uncapped digitals

He said he “did” such note with JPMorgan last year during the U.K. vote to exit the European Union, or Brexit.

It was JPMorgan Chase Financial Co. LLC’s $20.25 million of 0% uncapped digital notes due Jan. 29, 2018 linked to the iShares MSCI Emerging Markets exchange-traded fund, he said. The notes offer at maturity the greater of the ETF return and 21%. There is no downside protection.

He explained why he chose to do this structure with the issuer.

“We designed it. We didn’t need the downside. We can get 21% if the fund is up by a fraction. And we don’t have a cap, which we like very much.”

Citigroup Global Markets Inc. is the underwriter for the notes linked to the S&P 500. The Cusip number is 17324CE51.

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