Structured products issuance $239 million in short week; top stock deals reflect AI craze

By Emma Trincal

New York, June 28 – Structured products issuance volume was lackluster last week as markets were closed on Monday for the Juneteenth Holiday. With volatility muted and a tech rally raging, investors are selectively picking high-growth names when buying notes tied to stocks. This year’s favorite stocks are none other than the “Magnificent Seven,” which are leading the artificial intelligence bandwagon.

Agents sold $239 million in 32 deals last week, with single stocks accounting for 9% of the total and ETFs, 5%, according to data compiled by Prospect News. These figures are preliminary and will be revised upward as not all deals were filed with the Securities and Exchange Commission by press time.

Last week’s top deal was BofA Finance LLC’s $34.79 million of three-year autocallables linked to the least performing of the S&P 500 index and the Russell 2000 index.

Hawkish stance

Uncertainty came back in the markets last week as Federal Reserve chair Jerome Powell during his testimony before Congress suggested that more rate hikes will be “appropriate” by the end of the year.

Both the S&P 500 index and the Nasdaq dropped 1.4% in reaction to his comments. But views remained mixed and the market slightly bounced back this week on strong economic data regarding durable goods orders, consumer confidence and new home sales.

When caps make sense

Some advisers have adopted a more bullish stance with the S&P 500 index up 14% year to date. With bullishness comes less tolerance for caps. Others remain cautious, seeking protection in the face of further interest rate hikes or in fear of overstretched valuations.

Those taking a range bound approach are bidding on digital, absolute return and callable products.

A market participant made the case for leveraged buffered notes with caps.

“The S&P is fully valued but it’s mostly because of the big AI names. If you look at the rest of the index, we may still be negative for the year. Same thing for the Invesco S&P 500 Equal Weight ETF (RSP), which is still down from its February high,” he said.

Agents have priced $367 million of notes tied to this ETF in 70 deals this year, according to the data.

The bid consisted of eliminating the heavy weighting of big tech stocks in the S&P 500. The top five holdings represent a quarter of the index’s market value.

Caps make sense in this market, this market participant continued.

“The uncertainty we have and the strong runup in equity are a call for action for traditional buffered notes with a cap,” he said. “There is no reason to worry much about the cap.”

Tolerance for caps can be observed with a recent pickup in demand for income-generating notes. Agents last week priced $200 million of callable notes, making for 84% of the total. The market share of those products was 52% for the month to date versus 41% for the year, the data showed.

In essence, callable note buyers agree to cap their upside at coupon or premium level in a bid for income but also because they are more concerned about lowering risk than boosting returns, a source explained.

Unlimited gains

Attitudes toward caps vary based on what advisers are trying to accomplish, said Ken Nuttall, chief investment officer of BlackDiamond Wealth Management.

“With growth in general, we tend to avoid caps. We usually go longer, four to five years...that’s when you usually don’t see caps,” he said.

“As long as the cap is large enough, I don’t have a problem with that. A 15% or 16% cap is OK. But a 9% or 10% is not enough.”

The most popular way to uncap the upside has been the use of so-called “catapult” notes, he said. Those provide a one-time automatic call with premium. If the call fails to occur, the gains at maturity are uncapped and typically levered while the downside is partially protected.

An example is Bank of Montreal’s upcoming autocallable three-year barrier leveraged notes on the S&P 500 index. The notes are automatically called at the end of the first year if the index closes at or above its initial level, triggering the payment of a 11.6% annualized premium.

The payout at maturity is 1.5 times the upside return, with a 30% buffer on the downside.

“These notes have become extremely popular. Even if you may very well be called and capped out by the premium, most buyers expect to benefit from the enhanced return at maturity,” said Nuttall.

“But the tricky part is where do they fit in the portfolio? I don’t think of them as either income or growth. Generally, though, I’ll have to treat them as growth because you could miss the call and get stuck for five years.”

Magnificent Seven

On the other hand, investors buying notes tied to single stocks are exhibiting more optimism and less risk aversion even if the ultimate goal is yield enhancement. The top names that have been used this year reflect the so-called “AI craze,” according to the data.

“They call them the Magnificent Seven. They’re the big AI stocks that have been driving this rally this year,” said Nuttall.

These companies have been deemed by analysts to be the most committed to the development of artificial intelligence-based products.

The “Magnificent Seven” stocks are Alphabet Inc., Amazon.com Inc., Apple Inc., Meta Platforms Inc., Microsoft Corp., Nvidia Corp. and Tesla, Inc.

As a proof that structured notes investors can act as trend followers, the top seven underlying stocks that have commended the highest sales this year happen to all be “magnificent,” the data showed.

The top issuance volume on a single-stock this year comes from notes tied to Apple with $382 million sold in 89 offerings.

“Apple is going to be a beneficiary of AI even though it’s not really an AI company per se,” said Nuttall.

Amazon.com is second largest underlier with 121 deals totaling $361 million. Tesla, last year’s top underlying stock, has fallen to third place with $296 million in 89 deals, and Microsoft commanded the fourth position with $265 million. Nvidia ($238 million), Alphabet ($79 million) and Meta Platforms ($44 million) are the last three.

“We’re now seeing the reverse of last year. All those tech names got slaughtered in 2022, and they’re now driving the rally,” said Nuttall.

More stocks in June

The overall issuance volume for June through June 23 is $3.37 billion in 729 deals, a 25% decline from May’s notional.

But the month was characterized by a big push in stock-linked notes issuance, whose volume has jumped 23% to $669 million this month from $542 million during the same period in May.

“It seems like we’re seeing more individual stocks this year. It’s because of the volatility level,” said Nuttall.

The CBOE VIX index fell to a one-year low on Thursday at 12.73.

Unlike stocks, equity index issuance was down 38% for the month to $2.13 billion from $3.45 billion in May.

Big deals

The top equity index offering in June so far was Morgan Stanley Finance LLC’s $76.25 million of one-year 10.6% callables tied to the worst performing of the Nasdaq-100 index, the S&P 500 index and the Russell 2000 index paying a monthly fixed income.

The notes will be issuer callable after six months. The barrier at maturity is 70%.

The only structure that has grown in volume this month are fixed-to-floating rates. Their notional rose 48% from May to $163 million from $110 million.

Royal Bank of Canada priced the top one earlier this month with $89.05 million of three-year fixed-to-floating rate notes linked to the two-year U.S. dollar SOFR ICE swap rate.

This issuer also priced the top deal of the year, another fixed-to-floating rate offering on the same underlier for $381.73 million in February.

The No. 1 agent last week was UBS with $125 million in 15 deals, or 52.6% of the total.

It was followed by TD Securities and JPMorgan.

The top issuer was BofA Finance with four offerings totaling $62 million, a 25.9% share.

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