Wells Fargo's leveraged capped growth securities linked to S&P 500 aimed at moderate bulls

By Emma Trincal

New York, Aug. 30 - Wells Fargo & Co.'s 0% growth securities with leveraged capped upside and contingent downside protection due September 2014 linked to the S&P 500 index are designed for slightly bullish investors who do not expect the S&P 500 to grow by more than about 7% a year on average over the next two years, according to sources and based on a 424B2 filing with the Securities and Exchange Commission.

Investors are not overly bearish either, sources said, as they don't foresee a market decline of more than 20% in two years.

Investors with that type of outlook would get an attractive risk/return from the notes but could just as well "lose on both ends" if the market moves with more magnitude, an adviser said.

"It's a plain vanilla note for someone who truly believes that the market will be range bound over the next two years," said Steve Doucette, financial adviser at Proctor Financial.

"If this is true, theoretically, you can outperform the market in either direction.

"But if it goes outside that range, you lose on both ends."

The payout at maturity will be par plus 1.5 times any gain in the index, up to a maximum return of 19% to 22%, according to the prospectus. The exact cap will be set at pricing. Sources used a 20% hypothetical cap.

Investors will receive par if the index falls by up to 20% and beyond that will be simply long the index.

Tricky barriers

Doucette said that the downside protection is inadequate. Offered as a barrier rather than a buffer, the 80% strike could lead investors to lose everything once hit.

"Who would buy a note like this? If it gets breached, you get no protection. Your maximum is 10% per annum. And you can lose 100%," Doucette said.

"The risk/return characteristics of these notes wouldn't interest me in the least. A 20% decline is a normal bear market correction. So it can obviously happen.

"While I like those European barriers much better than those with a daily observation, it's still what it is: a barrier that can be breached."

Doucette said he would much rather have a buffer for the same 20% protection amount, acknowledging however that issuers would have a hard time pricing the product to make it attractive.

"I wonder how much you would be giving up on either of the leverage or the cap to get the buffer," he said.

"I know that you would take a hard hit on the cap to get a 20% buffer. We are in a very difficult environment for downside protection because volatility is so low. That's the problem with the options: you can't get symmetrical range."

But Doucette said he would not consider this type of structure without a buffer, which he prefers in general.

"Let's say the S&P 500 is down 47%. With a 20% buffer, at least you keep your first 20%, so you're only down 27%. That way, you outperform the market. But losing 47% on that deal would be a very different story," he said.

"But perhaps you could introduce a 20% buffer with a downside leverage component beyond the 20%. I'd rather have a buffer with downside leverage than this barrier of one-to-one from the initial price."

Doucette said that he is not necessarily bearish but that risks are real, making it necessary for advisers to be prepared for a negative outcome.

"You have a possible bear market, financial crisis, the fiscal cliff. I'm not saying we'll have another big crisis like 2008, but we've seen what it did. If the S&P goes behind that barrier, it all goes. If the market is screaming up, you're capped up; if it's screaming down, you're on your own," he said.

In the range

However, the notes appear to be a good fit for investors who do not believe the market is going to move much in the two-year period.

"It's a two-year, 20% cap, one to one-and-a-half leverage on the upside, 0% downside until you hit 20%. It's a very reasonable expectation for the S&P, and it seems like an interesting way to play the market," said Kirk Chisholm, principal and wealth manager at NUA Advisors.

Because the barrier is final, it allows a negative market cycle to play out on the first half of the term, which is when Chisholm said volatility could be the greatest.

"We suspect there may be a recessionary year at least coming in 2013. We don't think the world is going to end; we don't think there will be another 2008. But our view is that we're heading toward a down year. However, at the end of the two-year term, a 20% protection seems reasonable. More than 20% two years from now would be unusual. We think there is enough protection in this," he said.

The product is designed for bulls, but a very bullish investor would rule it out, he said.

"In the next two years it would be challenging for the S&P to be up 20%. Getting 10% a year is nice for any market," he said.

"But if you see a negative year in the S&P in 2013, as we do, it's more likely that the return will fall into the plus or minus 20% parameters.

"This product seems like a reasonable substitute for the S&P."

Wells Fargo Securities, LLC is the agent.

The Cusip number is 94986RLF6.

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