Wells Fargo’s trigger notes on Stoxx 50 provide terms for enhanced growth, potential alpha

By Emma Trincal

New York, Jan. 21 – Wells Fargo Finance LLC’s 0% capped trigger gears due Jan. 31, 2023 linked to the Euro Stoxx 50 index show a high leverage multiple, a double-digit cap and contingent protection, all features which may appeal to moderately bullish investors seeking exposure to the European market with enhanced growth potential.

The payout at maturity will be par plus 5 times any index gain, up to a maximum return of 40.5% to 44.5%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index falls by up to 25%, the payout will be par.

If the index finishes below the 75% downside threshold, investors will lose 1% for every 1% decline.

Concentrated benchmark

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said he would not use the notes as a core holding. However, he liked the terms.

“Obviously the issuer is on our list of investable issuers. Wells Fargo has a very good credit. From a planning standpoint though, the Euro Stoxx is not my favorite index. But at least for an international exposure, it’s one that clients are familiar with,” he said.

Kalscheur said he avoids investing in the Euro Stoxx 50 index because of the concentration of the benchmark around 50 stocks. In addition, the components of the index are not high-growth companies as is the case with many of the S&P 500 index constituents.

“There is a significant underweight to technology. One could argue that the S&P is overweight to tech, but with the Euro Stoxx, it’s the extreme opposite,” he said.

Cap

However, the combination of a 5x leverage, a 40.5% to 44.5% cap and the 25% contingent protection on the downside made the three-year note an attractive product.

“The terms are fantastic,” he said.

“On a three-year, to get 5x the upside with this cap is impressive...all you have to be is up less than 3% a year and you’re going to hit that top line.”

The maximum return would be 12% to 13% a year on a compounded basis for the lower and higher end of the cap range, respectively. To achieve this return, the index would only have to rise by 2.63% a year should the cap be set at 40.5% and by 2.88% a year at the higher end of the range for a cap of 44.5%.

“I usually don’t like caps because they’re too low. Taking equity risk to get an 8% return is not very compelling. I can get that type of return taking a lot less risk with a high-yield bond. But 12% to 13% is a rate of return that’s high enough to justify investing in equity,” he said.

Leverage

“If you’re going to take equity risk, you need to be compensated. Here, not only is the cap very good, you have 5 times leverage.”

Investing in the notes does not require a high level of conviction.

“You have to have a very small move in this index to get a very good rate of return. Obviously, if you think the index can do better on its own, the notes wouldn’t be for you,” he said.

Downside protection

Kalscheur liked the barrier too. Looking at historical data he has collected on the index since 2002, he found that a drop of more than 25% on any three-year rolling period happened 9.5% of the time.

“I wouldn’t put a lot of stock on this since the information isn’t old enough,” he said.

“Still...a 9.5% chance to get a 25% decline on the Euro Stoxx is not insignificant. But I feel comfortable enough to tell my clients that 90% of the time they’ll be above the barrier.”

Underlying issue

Kalscheur, however, would not use the note as a core holding due to his reluctance to get Euro Stoxx 50 exposure.

“But I could certainly use it as a supplement to an international holding,” he said.

“The barrier is low enough to give you downside protection.

“The cap is high enough to offer an equity-type of return.

“And with this very high leverage, you get an opportunity to outperform on the upside even though you’re giving up substantial dividends.”

The Euro Stoxx 50 index yields 2.60%.

“The terms are too compelling to pass.”

For mild bulls

Steven Foldes, vice-chairman of Evensky & Katz / Foldes Financial Wealth Management, shared Kalscheur’s appreciation of the terms although his view on the underlying index was much more positive.

“It’s an interesting note. It’s for someone who is reasonably pessimistic on the Euro Stoxx, an investor who is only mildly bullish on the index,” said Foldes.

“We think the Euro Stoxx is undervalued. Europe is cheap and it could go up a lot more than 12% a year. So we wouldn’t be interested in the note.

“However, the terms are very attractive if you have a more modest outlook on this asset class.”

The 75% barrier over three years is “nice” even if such decline is unlikely for that timeframe, he said.

“But it’s good to have.”

Value

The upside leverage was one of the most attractive features.

“You may be giving up 2.60% per year, but on the other hand, you’re getting a significant multiple,” he said.

The Euro Stoxx 50 index has shown some volatility. It was up 24.4% in 2017, then down 16.1% the next year to increase by 25.9% last year.

“From a valuation standpoint, we think you can get more than 40% to 44% in three years,” he said.

“This is why the note wouldn’t be for us.

“But for someone with a less bullish outlook... achieving a 40% to 45% rate of return while still having the downside protection, the high multiple and the issuer’s strong credit...is not too shabby.”

UBS Financial Services Inc. and Wells Fargo Finance LLC are the agents.

The notes will be guaranteed by Wells Fargo & Co.

The notes will price on Jan. 29.

The Cusip number is 95002W685.

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