Wells Fargo's access securities tied to MSCI EM ETF offer defensive exposure, limited upside

By Emma Trincal

New York, Aug. 21 - Wells Fargo & Co.'s 0% buffered and capped access securities due Sept. 3, 2015 linked to the iShares MSCI Emerging Markets index fund may appeal to investors seeking exposure to emerging markets while eager to focus on limiting the downside risk, sources said.

The structure, which offers no return enhancement but a mere 100% participation in the upside along with a 12.5% to 14.5% cap, suggests that some investors in some markets may prefer strong downside protection to accelerated returns, sources noted.

"It's a 20% buffer. If it falls 30%, I only have to explain to a client a 10% loss. We like that a lot," said Andrew Valentine Pool, main trader at Regatta Research & Money Management.

"It's true that the upside doesn't have any leverage or digital payout. So it's limited. But I can see myself doing it just because there is a 20% protection built in.

"It's the hardest thing having to explain to a client a large double-digit loss, especially when you have to explain to them [that] well, we put you in a relatively illiquid product. It's pretty hard to justify."

Buffer versus barrier

Pool compared the notes to other products linked to the same exchange-traded fund but offering a barrier instead of a buffer.

He looked at Bank of Montreal's upcoming 0% barrier bullish return notes due Sept. 2, 2016 linked to the ETF, which feature a barrier level of about 60% (in a 58% to 62% range according to the filing) and a daily observation period.

A barrier event will occur if the price declines below the barrier level on any day during the life of the notes.

The notes also offer a one-for-one return on the upside even though unlike the Wells Fargo deal they do not have a cap. But if a barrier event occurs, investors lose the downside protection and are exposed to the fund's decline from the initial price.

"I certainly prefer having the 20% buffer than a barrier even if it's a deep barrier" Pool said.

"It's a relatively illiquid product. The loss can be substantial. We like having control of our clients' assets.

"To have a potential 40% loss is not really our style.

"And the fact that it can be triggered any day makes it even less appealing."

Growth ahead

Pool said that he liked emerging markets as an asset class.

"I would have to do more research on the fund, but I'm positive on the emerging markets as a whole," he said.

"There's a lot of liquidity worldwide even though a lot is still in the coffer.

"Central banks have printed a lot of money, but the velocity of money has not increased much.

"But once that money starts going into the system and as people feel more confident, business will go back to an expansionary cycle.

"Rates will go up, but it won't jeopardize growth if you do it carefully."

Pool said that whether rates move up or not, emerging markets present a solid growth story.

"You have more and more people better educated, working and pushing the economy machine forward. I am pretty bullish on this asset class," he said.

Playing defense

A market participant said that investors in the notes would have to be conservative to sacrifice the enhanced return. But for some, the notes may provide access to an asset class considered to be relatively risky.

"It's a more defensive play," this market participant said. "And it's an interesting one.

"At first glance, you can say that it's a questionable trade when you don't get leverage on the upside. You even have a cap. It's a two-year, and the fund carries a 2% dividend yield.

"Let's say you're giving up 5% worth of dividend yield for the two-year timeframe.

"In every instance that [the] index is up, you're not making as much as if you had bought the index outright. But on the downside, the buffer really helps.

"Buffered notes are very attractive. It's the jewel of what our industry creates.

"Some of these buffered products give you a digital payout or some leverage. You don't have any of that with this one, but it's fine because first, it's such a short-term deal and second, the buffer is pretty substantial."

Getting exposure

This market participant imagined the choices available to an investor who would want to get exposure to emerging markets but who would be "afraid" of a downturn.

"You can either don't invest and sit on your cash or you can buy an index or this fund," he said.

"If you believe it's going to drop and don't want to be out of the market, this product offers a solution rather than staying in cash and sacrificing the potential gains.

"And it's a hard buffer. A 20% buffer is outstanding. It works well in a balanced portfolio.

"I suppose this type of product will get distributed in the private-wealth channel rather than the retail distribution network. It has a good downside protection, but it's still principal-at-risk.

"The larger banks, the parent companies of those private wealth groups offer a strong support to their advisers, who are more in the know when it comes to structured products. A lot of their clients are fee-based advisers who have been hired to reduce risk and increase alpha. This is precisely what this product does."

Wells Fargo Securities, LLC is the agent.

The notes will price Aug. 29 and settle Sept. 4.

The Cusip number is 94986RRD5.

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