JPMorgan’s leveraged notes linked to Vanguard FTSE EM ETF offer good risk-adjusted return

By Emma Trincal

New York, March 18 – JPMorgan Chase & Co.’s 0% trigger return optimization securities due March 29, 2019 linked to the Vanguard FTSE Emerging Markets exchange-traded fund offer bullish investors a high potential return considering the lower-than-average level of risk, said Suzi Hampson, structured products analyst at Future Value Consultants.

Her comment was based on the research report her firm generated for this product. Future Value Consultants rates structured products based on their value, risk-adjusted return and risk.

If the ETF return is positive, the payout at maturity will be par of $10 plus two times the ETF return, subject to a maximum return that is expected to be 43% to 47% and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

If the ETF return is zero or negative and the final share price is greater than or equal to the trigger level, 75% of the initial share price, the payout will be par.

If the final share price is less than the trigger level, investors will have full exposure to the ETF’s decline.

Bullish

“It’s a quite straightforward structure,” she said.

“It gives you exposure to emerging markets via another fund than the more commonly used iShares. But they’re both very similar.”

The short-term implied volatility levels are comparable at around 24%, she noted.

She was referring to the iShares MSCI Emerging Markets ETF.

In order to run the report, Hampson picked the 45% value at mid-point within the cap range. With a three-year duration and a factor of two for the leverage, investors may expect to gain a maximum return of 13% per annum on a compounded basis. This will be achieved if the share price of the ETF rises by 22.5% over the term, which is the equivalent of 7% on an annualized compounded basis.

“This note is designed for quite bullish investors because you still need to see a certain amount of growth in the underlying to reach your cap,” she said.

“The double gearing offers you a pretty attractive return of 13% a year. A less bullish investor would probably prefer a much more geared product with a lower cap. This product doesn’t work that way.

“Here you get a decent return potential and a reasonable chance of outperforming the underlying.”

Risk

The firm calculates the market risk and the credit risk and adds the two components to generate the “riskmap,” which measures on a scale of zero to 10 the risk associated with a product with 10 as the highest level of risk possible.

The notes have a market riskmap of 3.35 versus an average of 4.06 for products of the same type, according to Future Value Consultants’ research report.

The product type for this note is leveraged return.

“The share price of this fund can drop as much as 25% at the end of three years and you won’t lose any principal,” she said.

“You’re looking at a pretty generous barrier. And it’s observed at the end, not on an intraday basis.

“The protection is quite good for this product type. Other leveraged notes offer no downside protection or may offer 5% or 10% buffers. The size of this barrier makes a difference.

“Of course, you shouldn’t approach this as a low-risk strategy. Emerging markets are more volatile than developed countries. But the barrier gives you a fair chunk amount of capital protection in the case of moderate losses.”

The credit riskmap of 0.65 slightly exceeds the average in this category of product, which is 0.52.

She attributed the result to a combination of the issuer’s credit and the duration of the notes but stressed that the excess risk was minimal.

Adding the market riskmap and credit riskmap components gives a riskmap of 4.00 versus an average of 4.59 for similar products and 4.46 for all products.

“This level of risk sounds quite reasonable. It’s not a very long-term product. It’s not a very volatile underlying. The 75% barrier is on the lower end. I’m not surprised by the score,” she said.

Return score

The return score measures the risk-adjusted return of a note. It is computed based on the best among five market scenarios. In this case, the score derives from a bullish market assumption.

The product’s return score is 8.09 versus an average of 7.28 for similar products and 6.76 for all products.

“Again I’m not surprised by those results. You have a lower risk product within that category even though you still have the potential to lose all your money. It’s not a ‘no-risk’ trade by all means, but the product compares well with its peers.

“On the return side, you have the double gear and quite a high cap.

“This will perform very well in a bullish market.”

Price score

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The notes have an 8.52 price score while the average for the product type is 7.38.

“The issuer spent enough on the options to offer good value to the investors. This is what a high price score is telling us,” she said.

The choice of the underlier may have helped pricing. The Vanguard ETF offers a dividend yield of 3.48%, which is substantially higher than the 2.65% dividend rate paid by the iShares MSCI Emerging Markets ETF.

“The dividend payments lower the price of the forwards, which helps with the pricing of the options. The cost of the calls you need to buy when you provide leverage are going to be cheaper,” she said.

Overall score

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

At 8.30 the overall score is higher by nearly a point than the 7.33 average for the leverage return category. The difference is even greater when compared to all products, which have an average overall score of 6.52.

“All the scores for this product are pretty good. It gives you an overall well above the averages,” she said.

“As long as you get a high participation or a higher cap, there is no reason why the product wouldn’t score well against its peers.

“Emerging markets tend to be seen as a riskier part of the portfolio. This is for someone who wants the exposure but not a direct exposure via the fund itself. This note offers an alternative with a slightly lower risk but still quite a potential high return.

“It’s a trade-off. You get no dividends, but you have the barrier and the leverage.”

UBS Financial Services Inc. and J.P. Morgan Securities LLC are the agents.

The notes will price on March 28 and settle on March 31.

The Cusip number is 48128B804.

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