Slowest week of year so far shows investors still focused on capturing last leg of bull run

By Emma Trincal

New York, July 9 – As the Dow Jones industrial average hit its 17,000 milestone on Thursday ahead of the long Fourth of July weekend, structured notes issuance registered its slowest week of the year so far with agents pricing $549 million in 98 deals, according to data compiled by Prospect News.

The tepid action did not stop agents from bringing to market a few larger deals. Five offerings exceeded the $20 million size.

Three types of structures – leverage with no downside protection, absolute return notes and jump securities – dominated the week, leading observers to conclude that investors remain more bullish than skittish in their market outlook despite the new record highs in U.S. equity.

Lackluster action

“It was the first week of the month, the Fourth of July week, and we’re in the midst of summer. These three factors are not going to help volume,” said a structurer.

“Add to that a tricky pricing environment with low volatility and low interest rates, and I’m not surprised about the low volume. The conditions are just not there.”

Yet retail investors remain fundamentally bullish, he said.

“General sentiment is bullish. People think that a correction is likely, but it’s hard to say when or where it will come from,” he said.

“There doesn’t seem to be an obvious red flag. Even the fear around the Fed raising interest rates has only played out for a couple of days this week. There is a general consensus that the Fed is more likely to err on the side of caution than to be overly aggressive. The clients we’re talking to are cautiously optimistic.”

High leverage, short tenor

The most popular structure seen last week was short-term notes with high leverage, acceptable caps and no downside protection.

Deutsche Bank AG, London Branch priced $37.66 million of 0% capped leveraged index-linked notes due Oct. 6, 2015 linked to the S&P 500 index. The notes offer three times upside leverage capped at 13.11% with no barrier or buffer on the downside. It was the week’s largest deal.

The fifth largest deal fell into the same structure type: JPMorgan Chase & Co. priced $24.9 million of 0% Performance Leveraged Upside Securities due Aug. 5, 2015 linked to the Euro Stoxx 50 index. The leverage factor is also three, the cap is 14%, and investors are also exposed to any losses. J.P. Morgan Securities LLC was the agent with distribution through Morgan Stanley Wealth Management.

“This has been the best-selling structure for a while. Month after month, this structure does pretty well within the distribution channel it is sold to,” the structurer said.

The success of the structure results in part from pricing conditions, he added.

“It’s a combination of where the market is. Retail is bullish; they want to participate in the bullish trend. They get the leverage with a cap, and they don’t have too much of a need for protection,” he said.

“The second reason is technical. Sure, people want to have protection, but the caps when you put the protection become very unattractive. Most people decide that it’s not worth having it with such low caps, and so they give up the downside protection in order to get a higher cap or, even better, no cap at all.”

For a sellsider, investors seem anxious about missing the last days of the rally, which would explain their willingness to invest without a buffer or barrier in exchange for very short-term leveraged exposure.

“We hit a lot of all-time highs, and so investors might be a little bit nervous about a downturn. In that regard, it may seem a bit weird to do a deal with no downside protection,” this sellsider said.

“But the market remains fairly bullish, so there is still appetite for those deals. People expect a slight correction but not necessarily a big one. For some bulls, it might be a good idea to boost your structure with three-times leverage to capture the end of the bull market. It’s a trend-following type of trade. People are playing it really short term for that reason.”

Getting it both ways

Other deals in favor last week were absolute return or dual directional structures. Showing longer tenors, those notes enable investors to capitalize on a negative return of the underlying asset as long as the decline remains above a specified barrier. The upside is typically slightly leveraged and uncapped.

“It’s also a smart way to play with the uncertainty around the end of the bull market. You don’t know when and how much the market decline will be. You give yourself more time in order to capture both the upside and the downside. It makes sense,” the sellsider said.

Morgan Stanley priced $25.42 million of 0% dual directional trigger Performance Leveraged Upside Securities due June 30, 2020 linked to the S&P 500, which was the No. 3 sale last week. Investors participate in the upside at a rate of 112% with no cap if the index return is positive.

If the final index level is comprised between a 65% trigger level and the initial level, investors receive the absolute value of the index return.

If the index drops below the trigger, investors are fully exposed to the decline from the initial level.

“Another way to capture the upside is to lengthen durations,” the structurer said.

“Dual directional deals are a lot longer. It’s also structured around a barrier, not a buffer. It makes a difference in the way these things are priced.

“If you go longer, you have more pickup in interest rates because you go longer in the curve. If you go longer, you also have more pickup in volatility, for the same reason. It’s really helpful for pricing.”

Jump

Another type of structure enabling investors to fully participate in the upside were the “trigger jump” securities, which also sold well last week, sources said.

Those structures allow bulls to profit from a moderate or strong market rally by offering the index return subject to a floor.

One example was the No. 4 deal, HSBC USA Inc.’s $25.27 million of 0% trigger jump securities due July 6, 2020 linked to the S&P 500. If the index return is positive or flat, the payout will be par plus the greater of the index return and 34%. The downside offers a 60% barrier for contingent protection.

“It’s another way to catch the end of a bullish run,” the sellsider said.

“If you think the market will still increase in the coming months or years but not on a very strong basis, it’s pretty nice to get a minimum digital return if the market performance is flat. On the other hand, if you’re wrong, if the market continues to rally, you will be able to capture all of the upside since you have no cap.”

Large commodity deal

Equity-linked notes issuance continued to prevail last week, making for 70% of the total. The percentage was lower than the year-to-date average of 82% due to an unexpected push from commodities investors.

Agents sold seven commodities deals totaling $89 million, or 16% of the total. This market share was much higher than the 4.6% average for the year to date, according to the data.

Most of the commodities issuance volume originated from one deal, the second largest one for the week. It was JPMorgan’s $35.74 million of 0% return notes due July 5, 2019 linked to the S&P GSCI Brent Crude Oil Index Total Return. The notes replicate the performance of the index on a one-to-one basis, minus fees, a type of structure also known as delta one.

Institutional investor

Sources noted that alternatives exist to get exposure to Brent crude oil. An example would be the United States Brent Oil Fund LP, an ETF that tracks the spot price of Brent crude oil.

“Maybe they did it for tax reasons, as we know that tax implications are different between ETFs and ETNs,” the structurer said.

“Maybe the exact index is not available in ETF format.

“Or perhaps the client did not want the execution risk of buying $35 million worth of an ETF because the price could move against them. Rather than taking that risk, they outsourced the execution to JPMorgan and got the exposure through the note.

“Retail doesn’t do delta one. It’s probably an institutional investor doing a big-size deal and being concerned about a number of things, the execution being one of them.”

The top agent last week was JPMorgan with $190 million sold in 28 deals, or 25% of the total. It was followed by Morgan Stanley and Deutsche Bank.

“General sentiment is bullish.” – A structurer

“It’s ... a smart way to play with the uncertainty around the end of the bull market.” – A sellsider on absolute return structures

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.