Advisers reluctant to get exposure to three indexes in BMO’s $3.06 million autocallable worst-of

By Emma Trincal

New York, April 24 – Bank of Montreal’s $3.06 million of 0% autocallable barrier enhanced return notes due April 19, 2027 linked to the performance of the S&P 500 index, the Russell 2000 index and the Nasdaq-100 index provide an eye-catching call premium with the potential for uncapped leveraged participation, two appealing features, advisers said. But the use of three indexes rather than two or just one was a major roadblock for both of them.

The notes will be called automatically at par plus a 19.92% call premium if each index closes at or above its initial level on April 21, 2025, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 150% of any gain in the least performing index.

Investors will receive par if the worst performer falls by up to 30% and will lose 1% for each 1% decline of the worst performer if it falls by more than 30%.

Catapult deal

I find those catapult notes very attractive in general. It’s even more attractive when you’re being offered a 19.92% call premium,” said Steven Foldes, founder and wealth manager of Evensky & Katz / Foldes Financial Wealth Management.

“That said, I would need to modify it to make it acceptable to our investment committee.”

The marketplace has coined the term “catapult” to designate structures combining a one-time autocall paying a premium with the possibility of having uncapped leveraged participation at maturity if there is no call.

Credit risk, cost

Foldes brought up some minor concerns first.

“I’m not familiar with BMO so I can’t speak to this bank’s credit. That’s an issue since the most important thing with a note is the viability of the issuer,” he said.

The 0.5% fee, as disclosed in the prospectus, could also be a problem.

“0.5% is reasonable on a three-year. But since you may get called after one year, it’s on the high end,” he said.

Foldes, however, said he would not really debate the fee given the compelling terms.

“It’s tough to find a note linked to indexes that can pay 20% a year. If you don’t get called, you’ll have 150% of the upside with no cap at the end of three years, which is very compelling too,” he said.

In general, Foldes said he likes to invest in notes that are less than three years. But the specificity of the structure made it different in this case.

“In this instance, having three years is appropriate. If you’re down and don’t get called, you have two more years in which to catch up and hopefully get a decent performance,” he said.

Gaps in returns

Foldes said that his main objection to the deal was the number of underliers constituting the worst-of.

“Having a worst-of creates additional risks. The disparities of return between those three benchmarks are significant if you look at last year,” he said.

The Nasdaq was up 43% in 2023 while the S&P 500 index rose 24%. Meanwhile the Russell 2000 increased by 15%.

Cutting the number of underlying indexes would be a priority when negotiating the terms with the issuer, this adviser said.

“I would need to go from three to two benchmarks to mitigate the risk created by those huge differentials in performance,” he said.

Remodeling the structure

Improving the quality of the downside protection was another requisite.

“I would try to exchange the 30% barrier for a buffer.

“The 30% protection is not bad. But it’s a barrier, and a buffer is better. It allows me to really know what I may be losing.”

Aware that changing the worst-of structure and obtaining a buffer would require some concessions, Foldes said he could consider a smaller call premium.

“The 20% call premium is fantastic and I would like to get something very close to this rate. I would discuss what type of premium I could get. Anything in excess of 15% may be acceptable depending on the terms.”

“These would be the basis of a conversation. But overall, this is a very compelling offering,” he said.

Hard-to-get premium

Scott Cramer, president of Cramer & Rauchegger, had a more negative view on the structure. He expressed similar concerns.

“It’s a generous call premium. It’s a generous upside. But I don’t like the protection level and I don’t like the worst-of,” he said.

“To get that premium, everything has to be up on that day, a year from now.

“I’m not saying it’s impossible. But you may not get the premium.”

The macroeconomic picture was not encouraging.

“The Fed is having trouble cutting rates because inflation seems to be running hot,” he said.

Make it one

Cramer would go as far as eliminating the worst-of payout altogether.

“You’re locked in for three years if you don’t get called. I’m not saying it’s impossible to get called. But every time you have a worst-of, it makes it more difficult to pocket your call premium.

“I would rather have a big call premium on a single index, but of course, you can’t have it both ways.

“If I had to choose though, I would lower the premium and link the notes to one index only. I would get rid of the worst-of,” he said.

BMO Capital Markets Corp. is the selling agent.

The notes settled on Thursday.

The Cusip number is 06376ACQ1.

The fee is 0.5%.

© 2015 Prospect News.
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