BNP Paribas’ four-year notes linked to S&P 500 index offer sizable buffer, simplicity of terms

By Emma Trincal

New York, Nov. 10 – BNP Paribas’ 0% buffered notes due Nov. 30, 2018 linked to the S&P 500 index offer an attractive buffer for a four-year note considering the low volatility of the underlying index and the reasonable length of the term, sources said.

Investors have one-to-one exposure to the index gain with no cap.

If the final index level is greater than or equal to the initial level, the payout at maturity will be par plus the index return. Investors will receive par if the index falls by up to 20% and will be exposed to any index decline beyond the 20% buffer, according to a term sheet.

Carl Kunhardt, wealth adviser at Quest Capital Management, said that the first thing he likes about the product is its simplicity.

“It’s plain vanilla. There are not a lot of bells and whistles. I can explain it to a client in 30 seconds or less,” he said.

20% on four-year term

He also noticed that 20% buffers on S&P 500 index-linked notes have become less common for that type of maturity.

“I don’t think I’ve seen any 20% for less than five or six years on the S&P regardless of the upside. Whether it’s leveraged or not, capped or not, it’s very rare to see any 20% buffers nowadays on [that term],” he said.

“The fact that there’s no leverage does not bother me. What I see most of the time are the Raymond James products, and Raymond James has a bias against leverage. So basically I see notes like this one: one-to-one, point-to-point, uncapped. I am not seeing any buffer of that size for less than five, going on six years.”

Data compiled by Prospect News over the past six months confirmed the trend based on a review of notes linked to the S&P 500 index having at least 20% downside protection and being four years or less in duration. Invariably the protection was contingent (barrier), and in some cases the observation was monitored daily in addition to that.

When the observation was final, the barrier on the downside was also combined with a cap on the upside.

In other cases, issuers put together worst-of structures that combined the S&P 500 with another index – typically the Russell 2000 or the Euro Stoxx 50 – or with a fund. In such cases, the S&P 500 was not the sole underlier and the structure typically used a barrier as well, not a buffer.

Finally, when a true buffer was employed, notes fitting the description had a geared buffer, not a one-to-one loss for each point of index decline beyond the buffer.

Simple

“Most sellsiders looking at this note would probably find it a little boring,” Kunhardt said.

“There’s not much going on, which is why I like it so much. It’s not trying to be overly smart. It allows you to do a passive strategy, participating in the index while hedging your risk with a safety net.

“This is all I really ask a structured note to do. Don’t reduce my return on the upside, and give me some protection on the downside. If you do that, I’m happy.

“And just as important: don’t force me to take 20 minutes to explain it to my clients. Clients like what they can understand. When you start getting all sorts of bells and whistles, you lose them. It’s fine if you’re in the industry, if you’re the structurer playing with exciting exotic options and derivatives ... it’s probably intellectually fulfilling. But a client has to have a good reason to invest. For them it’s pretty straightforward. Just give me an opportunity to get exposure to the market where I stand better chances of not losing my shirt.”

Hedge

Scott Cramer, president of Cramer & Rauchegger, Inc., said that the notes could be used as a “partial” hedge.

“It might be a good option for someone who wants a long-term play on the S&P because you have some downside protection with no upside limit. Usually there is a cap,” he said.

“Protection is relative and depends on the market. There used to be five-year [notes] with a 100% downside protection, but we’re not getting that anymore.

“Realistically, if you want to get in the markets and have some downside protection, this is a reasonable way to do it.”

Hedging could be one of the benefits offered by the product to long-only investors, he said.

“It may actually work for someone who made a lot of money in the market and wants to hedge part of it out,” he said.

“An investor who owns the S&P ETF may sell off part of his position, buy this and use the protection to get partially hedged.”

Market cycle

Even if some notes are much longer in duration, advisers said it may be long enough to include periods of market decline.

“With a four-year tenor, there is always the risk of incurring a market correction,” Kunhardt said.

“I don’t see us going for years without a correction. I have been expecting a correction since the summer. We are at an all-time high. Every time since the past 100 years that the market is at an all-time high, it invariably corrects.

“Does it mean one shouldn’t invest for the next four years? Of course not.

“It’s true that if the correction happens early on, it’s not as good as if it hits at the end.

“For any period of time, if you have a loss coming in the front end, it’s always the worst-case scenario because if you’re down 50%, you have to get 100% in positive return to get back to normal. So it’s always best if the downturn happens at the end.

“But it doesn’t mean investors should not be in the market. How often are you going to get a 20% correction over a rolling four-year period? It’s not necessary to try and figure out in advance what level of correction we’re going to have and when. We don’t know. So if an investor is trying to decide whether the 20% buffer is enough in this market cycle, I would say no, it’s not enough. A 100% protection would be preferable, but it’s not realistic.

“You always have to decide on an investment in relation to the alternatives. Is 20% enough? Relative to what? Unless you’re not going to participate in the market at all, a 20% buffer is better than a barrier, and 20% of anything is better than holding the position long.”

Point-to-point

Cramer said that investors always face the challenge of the uncertain future but that structured notes’ payouts pose their own risk when the return is calculated at a later date from the initial price.

“This is the danger of any note with a point-to-point. Anytime you have a point-to-point, you look at one day in time in the future and that’s mistimed. That’s always the risk,” he said.

Cramer said the terms of the notes are attractive.

“The fee is very reasonable. The structure is simple, which is good because you don’t have to be a math major to figure out what they have to say,” he said.

The sum of commissions and fees will not exceed 75 basis points, according to the term sheet.

“We’re seeing increasingly complicated structures recently, and it’s not a surprise given the low interest rates environment. But for sure, I like simplicity when I see it,” he said.

“Overall, I like this product. As a hedging structure for a portion of your portfolio, this has a place.”

The notes (Cusip: 05579T5P7) are expected to price Nov. 24 and settle Nov. 28.

BNPP Securities is the agent.

In a separate term sheet, BNP Paribas said it plans to price on the same day 0% buffered notes due Nov. 30, 2018 linked to the Dow Jones industrial average. The notes (Cusip: 05579T5M4) have the same structure except for the buffer, which is 15% instead of 20%.

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