Eksportfinans, Svensk price six deals with triple leverage, no buffer as investors seek yield

By Emma Trincal

New York, Feb. 1 - Merrill Lynch priced six deals on the behalf of Eksportfinans ASA and AB Svensk Exportkredit that gave buyers a lot of leverage but no protection. They were met with strong demand as investors are eager to maximize their returns in an environment of low volatility, sources said.

All of the deals consisted of 14-month notes; all offered three-times leverage and no buffer or protection; all were relatively large in size - the smallest transaction was $20 million and the largest nearly $70 million - and two-thirds of the deals consisted of commodities-based products, according to 424B2 filings with the Securities and Exchange Commission.

The deals priced the same day, Thursday.

Sources noted that the appetite for leveraged and non-buffered products came from mildly bullish investors who are not worried about a correction but want to maximize returns in a market they anticipate will trade range bound.

"Investors want to use the low volatility to lever up the upside. They're expressing their confidence that way. You either buy the upside or buy the downside. They're confident. If they were not confident, they would buy the protection," a market participant said.

Mostly commodities-based

The six deals were the following:

• Eksportfinans priced $69.68 million of 14-month 0% Accelerated Return Notes linked to the Rogers International Commodity Index - Excess Return. The maximum return at maturity is 13.55%;

• Eksportfinans priced $68.66 million of 14-month 0% Accelerated Return Notes linked to the Energy Select Sector index. The cap is 17.88%;

• Eksportfinans priced $63.17 million of 0% Accelerated Return Notes due March 30, 2012 linked to the Financial Select Sector index. The cap is 18.85%;

• Svensk priced $37.34 million of 0% Accelerated Return Notes due March 30, 2012 linked to the S&P MidCap 400 index. The cap is 15.54%;

• Svensk priced $49.83 million of 0% Accelerated Return Notes due March 14, 2012 linked to the spot price of copper. The cap is 31%; and

• Svensk priced $20 million of 0% Accelerated Return Notes due April 3, 2012 linked to the spot price of gold. The cap is 15.51%.

Low VIX

For the market participant, the emergence of such notes is a direct result of the decline in volatility, which makes leverage more accessible to investors.

The Chicago Board Options Exchange Volatility index, or VIX, is now below 20. It was at 26.7 at the end of August and at 23.5 at the end of November.

"Implied volatility has been coming down quite a lot," he said.

"When volatility is low, leverage becomes much cheaper because people get leverage by buying options on the upside. The investor is buying the call options for the upside. Volatility is low so they can buy more of it. That's how they get leverage.

"Instead of a buffer with two-times leverage, they get the three-times leverage with no buffer.

"It's really a choice between the upside and the protection."

Investors who make this choice, he explained, have a particular view on the underlying.

Noting that four out of the six underlyings belong to the same asset class, he said, "These are mostly commodities deals. It's a play on global growth, with investors seeking to hedge against inflation."

He took the example of the notes linked to gold with a 15.51% cap and said that investors in those notes were not very bullish.

"It's a play for mildly bullish investors. They see gold going up by 5% for the year or trading sideways. They're using the low volatility to lever up and express their view," he said.

Not a mainstream play

Frederick Wright, partner and chief investment officer at Smith & Howard Wealth Management, said that investors in the notes had very specific views.

"It's not necessarily for the mildly bullish investor," he said.

"You could have a 15% cap with three-times leverage, it doesn't mean you necessarily think the return is going to be 5%. You might think it will be 10% and still like it."

Wright said that the notes could only be a good fit for a limited number of investors.

"People who do that are obviously interested in leveraging up the upside since you're not getting the downside protection. There's a mentality out there that's looking for that type of investment," he said.

"That's not something we would be interested in at our firm. Most of our clients like the idea of downside protection. We want to give the downside protection and still offer the upside participation.

"But there may be some hedge funds out there or some institutional funds whose clients want that."

Wright said that structured products could be used in different ways - "relatively aggressive like this one or more conservative."

Investors in the notes cannot be overly bullish, otherwise they would not tolerate the cap, he said.

At the same time, the product is not a good fit for the bears given the lack of downside protection, he added.

"It could [be a good fit] for someone who thinks, 'I don't think we'll have a correction, but I don't think we'll have a big run either,'" he said.

"And perhaps this is a reflection of the low volatility out there."

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