Bullishness, diversification drove bid on Deutsche Bank's $108.07 million notes linked to EAFE

By Emma Trincal

New York, July 24 - Deutsche Bank AG, London Branch's $108.07 million issue of 0% return enhanced notes due Aug. 6, 2014 linked to the MSCI EAFE index was the most popular offering last week. Sources cited the international equity exposure away from U.S. stocks and the bullish structure as the main drivers of the successful offering.

The payout at maturity was par plus double any gain in the index, up to a maximum return of 22.3%. Investors were exposed to any losses, according to a 424B2 filing with the Securities and Exchange Commission.

The notes were distributed by JPMorgan.

Non-U.S. exposure

"The EAFE index is an interesting play at this time," a market participant said.

"If you consider the S&P to be the conservative investment and emerging markets as the more aggressive one, the EAFE is somewhat in the middle. It's more of a moderate exposure to the international markets. It allows you to invest outside of the U.S. and to get exposure to a market that has underperformed the U.S. But the fact that you're still invested in developed countries gives you less downside risk."

The MSCI EAFE index is up about 7.5% so far this year while the S&P 500 has gained 18.2%.

The MSCI EAFE index is an international equity benchmark tracking 22 developed country market indexes excluding the United States and Canada. The index includes stocks from Europe, Australasia and the Far East.

Japan is the top country in the index with a 22.66% weight. The United Kingdom is second with a 21.25% weight, followed by Switzerland (9.34% weight), France (8.87% weight) and Germany (8.54% weight).

"In this bullish environment, it makes sense to diversify exposure to include foreign markets. People are not ready for emerging markets yet and for good reasons. Look at the Brazilian stock exchange performance. People have yet to see these markets as opportunities. It may change of course. But in the meantime, investors are more comfortable with the EAFE index," the market participant noted.

The MSCI Emerging Markets index has dropped 10.5% year to date.

The need to diversify away from the U.S. equity markets was probably a major reason behind the large size of the deal, said Andrew Valentine Pool, main trader at Regatta Research & Money Management.

"From a structure standpoint, we are more downside-protection-oriented, so we wouldn't have done this deal," he said.

"But I can understand why people would have an interest in EAFE. I know that for us, we would be looking at EAFE as well because we're over-concentrated in the domestic market, so the diversification rationale makes sense here.

"I suspect it was one factor behind the size of this deal. People are looking to diversify away from the U.S.

"This is also an index that has underperformed the U.S. If you're a bit heavy on U.S. stocks as a percentage of your overall portfolio, it makes sense to look for opportunities outside of the U.S."

Bullish terms

For the market participant, investors were also attracted to the note because of its bullish structure, not just because of the underlying index.

"It's the type of deal that JPMorgan distributes within their channel. It's one of their classic structures," he said.

"You have the developed countries equity market story. You have to like the story first. But then you look at how the story is delivered to you.

"It's a very simple, straightforward, transparent product, very easy to understand.

"You have double exposure to the upside, a generous cap, a short-term duration and no downside protection. No moving parts here.

"The terms are quite attractive. It's the type of product that has value versus a traditional equity investment because in the 0% to 22% range, this product can easily outperform a direct investment in the index. It's probably aligned with the client's view as to what's achievable in the EAFE space.

"And for a short-term deal, a cap over 22% is quite attractive."

Andrew Valentine Pool, main trader at Regatta Research & Money Management, said that he understood why the structure would appeal to bulls, although he would not have chosen to invest in the notes.

"We won't do notes with no buffer or barrier. It's not something we would be interested in. I don't talk enough with other advisers to know if deals with full downside risk exposure are becoming more popular. The bullishness makes sense in a way since we've been hitting new highs. People tend to expect that the market is going to rise even higher. But we don't operate that way. In fact, the more we see the market hitting new record highs, the more cautious we are. So for us, a note without any downside protection is not something we would consider at this time," he said.

The notes (Cusip: 25152RDW0) priced on July 19.

JPMorgan Chase Bank, NA and J.P. Morgan Securities LLC were the agents.

The fee was 1%.

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