JPMorgan’s outperformance PLUS tied to value, growth indexes offer relative value bet

By Emma Trincal

New York, April 8 – JPMorgan Chase Financial Co. LLC’s 0% outperformance Performance Leveraged Upside Securities due April 14, 2022 linked to the MSCI ACWI Value index relative to the MSCI ACWI Growth index provide investors a conservative way to bet on global value stocks.

If the value index outperforms the growth index, the payout at maturity will be 150% of the outperformance return, capped at 19%, according to a 424B2 filed with the Securities and Exchange Commission.

The outperformance return is the return of the value index minus the return of the growth index.

If the value index underperforms the growth index, the payout will be par plus the outperformance return, which will result in investors receiving less than par.

Bespoke deal

“This is probably a customized deal expressing the view of a client or maybe the opinion of strategists at JPMorgan private bank. It looks more like a customized deal to me,” said a market participant.

“For a long time, value has underperformed growth. The idea here is that you’re going to see a reversal of that trend.”

Usually issuers cap the return of a note in exchange for some form of downside protection, which is missing in the structure. He explained why.

Pricing constraints

“They had to cap the upside. The pricing of the leverage probably wouldn’t have worked without it. There is no downside protection probably for the same reason,” he said.

The absence of any barrier or buffer along with the limited upside made for a hard sell at first, he noted.

But investors could find other benefits, starting with the way value has been lagging growth for a long time.

“Value investing has been so challenged for so many years, you’re probably getting in this trade at a pretty attractive entry level,” he said.

Laggard index

From 2006 to 2019, the MSCI ACWI Value index has outperformed the MSCI ACWI Growth index in only three years – 2006, 2008 and 2016, according to MSCI Inc., the index sponsor.

The outperformance return was the highest in 2016 and 2006 with 9.78% and 9.69%, respectively. The difference between the two styles was nearly flat in 2008: value outperformed growth by 1.68% only during that year.

Access deal

The tradeoff might not look attractive, but the real benefit of the structure is to allow investors to gain access to a hard-to-replicate investment, he said.

“It’s difficult to play these kinds of relative value trades,” he said.

“If you want to be long value you can do that. But it’s hard to pair the two and find an instrument that’s long value and short growth at the same time.

“That’s the type of situations where you have to rely on a structured note for access.

“You go to a bank and ask them to carry this access trade for you.”

Relative value

This particular relative value trade may be less risky than a pure directional bet, he said.

“If you’re just long value you can lose a lot during a systematic sell-off. If you pair the two, value versus growth, you can reduce your loses,” he said.

For instance, in 2008, the MSCI ACWI Value index dropped 41.03% while the MSCI ACWI Growth index fell by 42.71%. The underlying of the notes (relative value) would have been a net positive return of 1.68%, which would have provided the noteholder a 2.52% positive return after leverage.

“You can see they don’t diverge that much, so in a way, it doesn’t really matter so much to have a cap,” he said.

Pairing the two indexes also makes the need of downside protection less crucial than for a pure directional play.

Not without risk

In theory though, the trade can create significant losses if the divergences are pronounced or if the amplitude of the returns vary significantly from one index to the other.

For instance, last year, the underlying value index yielded a 21.52% positive return versus 33.17% for growth.

The value index therefore underperformed growth by 11.65%, which would have been the amount of the losses generated by the notes assuming those results were over a two-year period.

When investors bet on the relative value of two indexes, they can still lose money even if both segments of the market are up.

The company, not the style

“It’s too complicated,” said an industry source.

“In this market, you have to look at each company as it comes.

“Value or growth...If you start labeling companies it doesn’t mean anything.

“You want companies with cash like Apple. Very solid companies that have been around for a long time, with strong balance sheets.”

Apple is the second largest holding of the MSCI ACWI growth index.

“We’re in a situation where many companies can collapse. You have to do your homework and pick the stocks based on the strength of the business,” the source said.

“How will the coronavirus crisis affect the bottom line? Will the business get hit by the lockdowns?

“That’s what you need to look at.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent. Morgan Stanley Wealth Management is the dealer.

The notes will price on Thursday.

The Cusip number is 48132J124.

© 2015 Prospect News.
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