Wells Fargo's growth securities linked to S&P 500 are meant for investors with tepid outlook

By Emma Trincal

New York, Dec. 17 - Wells Fargo & Co.'s 0% growth securities with leveraged upside participation to a cap and buffered downside with multiplier due Dec. 28, 2015 linked to the S&P 500 index are designed for investors who expect tepid growth in the index and are cautious about a potential downturn, sources said.

The payout at maturity will be par plus 150% of any index gain, up to a maximum return of 16% to 19%. The exact cap will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 10% and will lose 1.1111% for each 1% decline beyond 10%.

Low cap

Dean Zayed, chief executive of Brookstone Capital Management, said that the terms limit the upside too much without necessarily offering adequate protection.

"The buffer looks good at first, but the cap is too low," he said.

"The only good part of the deal is the two-year tenor.

"2014 will be more volatile. You'll need a greater cap and also more downside protection than 10%.

"Given the cap and the buffer, the terms are not very attractive, especially with what you lose after the buffer since your losses are compounded by the multiplier."

Even with the relatively short tenor, Zayed said that "I want to see a higher cap and more of a buffer."

Because the cap is already "low" in his view and because the 1.5 times leverage factor enhances returns, Zayed said that buyers of the notes would have to expect very little growth from the benchmark over the course of two years.

"Investors in these notes don't see the S&P doing much. If you factor in the upside leverage, it doesn't take a lot of growth to hit the cap. We're talking about mid-single-digits returns," he said.

"This is geared to investors with a very narrow perspective on the market, basically people expecting a flat market with not much going on either way.

"I don't see a lot of people with this type of view. There are still a lot of raging bulls out there.

"This product is tailored to a specific type of client. It's not likely to be popular among the majority of people."

Fear of a pullback

Tom Balcom, founder of 1650 Wealth Management, agreed that investors in the notes are only mildly bullish. But he said that there may be some demand for these types of products, with the exception of the very bullish investors.

Taking into account the compounding factor, the annualized return is 7.7% to 9.1%, he said. Accounting for leverage, it would only take a 5.13% to 6% annualized return from the S&P 500 for investors to hit the cap, he said.

"This is for investors who think that the market has had a nice run-up and that there is not necessarily a lot of upside left. But if there is, they don't want to miss it," he said.

"They want to be exposed to the market, maybe because they've been missing some of the gains. They want to benefit from potential upside while playing it safe.

"It could be for an investor who has stayed on the sidelines and wants the market exposure but remains cautious. People tend to worry about a pullback.

"Or it could be for investors who would just want to lock in some gains."

Balcom said that Wells Fargo is a creditworthy issuer.

"It's a good way to remove some credit risk because Wells Fargo is rock solid paper," he said.

Comparing the notes with a direct investment in the index, he said that the noteholders, while not getting paid the 2% annualized dividend yield, could outperform the index in a downturn scenario providing that the losses stay limited.

"If the index drops, even if you're not getting the 4% dividend over the two years, you're still ahead thanks to the buffer," he said.

"If the S&P declines by 15%, the person long the S&P would lose 11% while you would only lose 5.5% in that case.

"Of course, if you get a more serious decline, your protection starts to suffer from the leverage on the downside.

"The question really is how much you think the S&P may go up or down in the next two years.

"This is probably more geared toward someone who doesn't expect a serious correction.

"At least it's definitely the wrong trade for the ultra-bull."

Wells Fargo Securities, LLC is the agent.

The notes will price Monday and settle Dec. 27.

The Cusip number is 94986RSF9.

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