Citigroup’s PLUS tied to WisdomTree Japan Hedged Equity fund target dollar, Japan bulls

By Emma Trincal

New York, Jan. 18 – Citigroup Global Markets Holdings Inc.’s 0% Performance Leveraged Upside Securities due May 3, 2018 linked to the WisdomTree Japan Hedged Equity fund should appeal to investors who are bullish on the Japanese stock market but who need to remove the currency risk exposure.

The underlying ETF provides broad exposure to Japanese dividend-paying companies with an exporter tilt, according to WisdomTree. But the fund is mainly known for its currency hedge feature, which allows investors to get full access to the Japanese stock market in a weakening yen environment.

If the final share price is greater than the initial share price, the payout at maturity will be par of $10 plus 300% of the ETF return, subject to a maximum return that is expected to be at least 18.05% and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

If the final share price is less than the initial share price, investors will be fully exposed to the decline.

Hedge

Investors with equity exposure to a foreign market can suffer adverse consequences on their return when the local currency weakens against the dollar. Inversely they benefit from a depreciation of the dollar against the currency.

“The currency hedge is really important,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.

“If you don’t have a hedge you’re going to lose money when the dollar rises against the yen.

“So what you do is you buy a basket of Japanese stocks, you sell the yen, you have no yen exposure. You’re long Japanese stocks in U.S. dollar terms. That’s the hedge.”

Swap

The hedge provided by the underlying ETF was not even necessarily expensive, he added. On the contrary, Japanese government bonds have negative rates and as such, their yield is lower than in the United States.

The two-year rate in Japan is minus 0.23% versus plus 1.20% for the two-year Treasury.

“You sell the yen at a lower yield. You buy the dollar at a higher yield. One gets paid to hedge,” he said.

“You’re selling the yen in the forward market. It’s basically an interest rate swap.”

For dollar bulls

Getting exposure to the underlying ETF via the note would make sense for investors who expect further easing in Japan as well as a continued U.S. dollar rally, he said.

“You’re bullish on the dollar but you still think U.S. stocks are overvalued. You like Japanese stocks but you don’t like the yen. That’s why you would buy this,” he said.

He offered the example of an investor who would have invested in the Japanese stock market over the past six months: without a currency hedge, this investor would have earned a 5% return. But with a hedge, the gain would have been 13% over the period, as a result of the dollar moving higher, which hurts the unhedged portfolio, he explained.

Similarly, an investment in the Mexican stock market in pesos over the past six months would have led to an 18% loss. If hedged, however, the position would have only lost 1.7%.

Downside

While the hedge made sense, the absence of any barrier or buffer on the downside made the investment risky, he said.

“It’s a question of volatility. How volatile the Japanese stock market is? Fifteen months is a long time,” he said.

The Nikkei 225 index peaked in July 2015 at 20,500, he noted. The Japanese benchmark closed at nearly 18,900 on Wednesday.

“The Japanese market had a big rally and then a big sell-off,” he said looking at the chart.

“The index sold off in February at 15,000 then retested that low in June. Then it climbed up, took another leg up in the beginning of the fourth quarter and now it’s trading sideways, slightly down since the beginning of the year.

“It’s quite volatile. I would be cautious about being fully exposed to the downside,” he said.

Private wealth

A market participant said that those types of notes are usually bought by more sophisticated investors who have a bullish view on a particular asset class and have less interest in risk mitigation than in maximizing the upside.

“This is an attractive structure for the wealth advisory distribution channel. It’s definitely not for the broker-dealer space,” he said.

“The broker-dealer space is a little bit more focused on income substitute as opposed to performance.

“The wealth management side of the business, and that would include wealth management groups on the broker-dealer side, are definitely more in search of growth.

“They want to increase alpha in short-term trades rather than getting the protection on the downside.”

Citigroup Global Markets Inc. is the underwriter. Morgan Stanley Wealth Management is acting as dealer.

The notes, which will be guaranteed by Citigroup, Inc., will price Jan. 31.

The Cusip number is 17325E192.

© 2015 Prospect News.
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