RBC links to financial stock basket; product risky, but can outperform direct investment: adviser

By Kenneth Lim

Boston, July 21 - Royal Bank of Canada's planned accelerated notes linked to a basket of financial stocks is a play on a beaten-down sector, but the product's terms reflect a highly volatile underlying, an investment adviser said.

RBC plans to price a series of zero-coupon bullish enhanced return notes due July 29, 2011 linked to a basket of 12 financial stocks.

The basket comprises equal weights of the stocks of Bank of America Corp., Fifth Third Bancorp, KeyCorp, PNC Financial Services Group, Inc., Regions Financial Corp., SVB Financial Group, SunTrust Banks, Inc., State Street Corp., TCF Financial Corp., U.S. Bancorp, Wells Fargo & Co. and Zion Bancorp.

At maturity, investors will receive par plus double any gain in the basket, subject to a maximum total payout at 145% of the principal. Investors will lose 1% for every 1% decline in the basket.

Volatile sector

Products that are linked to the financial sector reached their peak in popularity at the start of 2008, the adviser said. The financial crisis had yet to fully develop, and there were still pockets of optimism about the banks. But the collapse of Bear Stearns and Lehman Brothers took the sector out of play.

"Volatility was very high, which on paper meant that you could get really good terms on products linked to the sector if you wanted, but of course nobody in their right mind wanted to be exposed," the adviser said. "Nobody knew what was really going on in their books, nobody could predict where their stocks were going to go or how long the recession was going to last. It was highly volatile for a reason."

Some of the stocks could have been oversold, but a considerable amount of fog remains in the sector, the adviser said.

"Many investors are still unwilling to buy structured notes from these banks, much less bet on their stocks," the adviser said. "I think some of the stocks may be undervalued, and there's certainly potential for gains because they don't have very far to go on the downside. But it's a very risky call to make."

Reward for risk

The RBC notes do not have any downside protection, which is a negative considering the underlying, the adviser said.

"You're capping me at 45% on the upside, and you're not giving me anything on the downside when this is a sector that could very easily be down," the adviser said.

But the downside risk is not too much worse than buying the underlying stocks directly, and taking on the risk can potentially reward investors because the return cap is still high enough to beat most other investments, the adviser said. The leverage is also a positive factor that could help investors to outperform a direct investment and the broader market.

"Double the upside is a very respectable participation rate," the adviser said. "If you're confident in the underlying stocks and you're confident about the issuer's creditworthiness, this could be a useful investment to have."

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