Citigroup’s barrier securities tied to Stoxx Europe 600 show good terms on narrow sector bet

By Emma Trincal

New York, April 18 – Citigroup Global Markets Holdings Inc. plans to price 0% barrier securities due April 23, 2020 linked to the Stoxx Europe 600 Banks index, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be guaranteed by Citigroup Inc.

If the index return is positive, the payout at maturity will be par plus 2 times the index gain, subject to a maximum gain of at least 67%.

The payout will be par if the index falls by up to 30%, and investors will be fully exposed to any losses beyond 30%.

The Stoxx Europe 600 Banks index is one of the sector indexes derived from the broader Stoxx Europe 600 index, which contains the 600 largest stocks of 17 European countries.

Top components in the Stoxx Europe 600 Banks index include HSBC, Banco Santander, BNP Paribas, ING Group, UBS Group, Barclays and Societe Generale.

Tactical play

Jerry Verseput, president of Veripax Financial Management, said he liked the terms of the notes. However his preference is to avoid sector bets. Using the notes as a tactical play would be a possibility for some investors however.

“If you have a conviction, if you think the banking sector in Europe is undervalued, this is a great way to participate in it,” he said.

The terms of the notes enable investors to earn a maximum return of 18.65% a year on a compounded basis.

“The notes would be great if you’re bullish and expressing a view. It’s only three years, you get this high cap and if the market is down you get 30% on the downside,” he said.

Narrow bet

But he would not consider the notes as they don’t fit his asset allocation style.

“Not only do you have to like the underlying, but you have to be able to follow it,” he noted.

“When we want to get exposure to Europe we look at the Euro Stoxx 50. Getting exposure to the European banks is an awfully thin slice for us. How many of these sectors do you need in order to have a diversified portfolio?”

Some advisors do make tactical plays, he noted, but not his firm.

“When we make sector bets, we use mutual funds,” he said.

This advisor prefers broad-based indexes because investors tend to be unfamiliar with a particular sector or country.

“If that sector happens to underperform everything else, you get in trouble with your clients. If they leave you because of that, you would have done them a disservice,” he said.

Terms

Steven Foldes, vice-chairman of Evensky & Katz / Foldes Financial Wealth Management, also found positive features in the deal. His concern was the volatility of the underlying index.

“We like Citigroup. Their credit fortunes have really improved since the financial crisis,” he said.

“The cap is very nice, and having leverage is always good.”

But for the rest, Foldes said that, “we don’t love the note.”

His first objection was the three-year tenor.

“It’s a little bit too long for us,” he said.

The 2% fee disclosed in the prospectus was also an issue.

“For a three year, it’s a little rich. Since we’re fee-only, this is something we would negotiate away. We don’t need the fee. It would go into our clients,” he said.

Broader allocation

The main drawback however was seen in the choice of the underlying index.

“We don’t like to invest in sectors. Even a country or regional index is too narrow for us. We typically don’t just invest in Europe. We allocate to international and we use the EAFE for that,” he said.

The MSCI EAFE index tracks the performance of developed markets outside of the United States and Canada. It has a large weighting in European stocks.

Betting on a sector within a particular geographic area narrows the underlying market even more and may end up being a risky strategy.

Volatility

“You’re going to have volatility on the downside and on the upside,” he said.

“You could be down more than 30% and you would have no protection.”

A buffer would be preferable for this reason, he said.

“We recognize the buffer would be smaller than a barrier, probably closer to 15% or 20%, but your protection would be much better,” he said.

Foldes said he would take less leverage for a buffer.

The risk on the upside was also to be considered even if the cap was admittedly high.

“Because of the volatility, this asset class could really take off,” he said.

“We certainly had a huge move in the U.S. after the elections.

“You can perfectly imagine being capped at 67% after three years and losing a greater opportunity to participate because this asset class has been so volatile.

“Whenever you make a sector bet, you look for a big win, and this would not necessarily be as big a win as you might like.”

Citigroup Global Markets Inc. is the underwriter.

The Cusip number is 17324CGX8.

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