Scotia’s $298,000 trigger notes with absolute return on Stoxx 50 seen as a long trade

By Emma Trincal

New York, Oct. 27 – Bank of Nova Scotia’s $298,000 of 0% trigger index-linked notes due Oct. 30, 2025 linked to the Euro Stoxx 50 index offer an attractive structure both on the upside and downside, advisers said. But they are reluctant to commit to a five-year investment period, they added.

If the final index level is greater than the initial level, the payout at maturity will be par plus at least 125% of the index return with the exact participation rate to be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes negative but above the trigger level, 70% of the initial share price, the payout at maturity will be par plus the absolute value of the index. Otherwise, investors will be exposed to the index decline from the initial price.

Dividend, leverage

Jonathan Tiemann, president of Tiemann Investment Advisors, said that the duration and the choice of Europe as the underlying were the key issues when deciding whether to buy the notes or not.

“As usual, you lose the dividend, and you lose it over five years. Five years is a long time,” he said.

The 1.25x leverage factor however helped offset the non-payment of dividends. The index yields 2.62%, which represents an opportunity cost of 13.1% for noteholders.

If the price return of the index is 50% at the end of the five years, noteholders will break even, he said.

The leveraged notes in this case would return 62.5% compared to a 63% total return on the index, he noted.

“That’s a 10% per year price return. It looks like a high hurdle, but that’s how you pay for the protection and the absolute return on the downside,” he said.

Downside payout

Tiemann said he liked the downside payout but that making a call on Europe over a five-year term was difficult.

“Five years... point to point...no autocall... It’s sort of fire and hope for the best...”

Tiemann said the downside payout was appealing.

“The index is down 20% and you gain 20%. That certainly adds value on top of the protection and 30% is a substantial protection. But you have to be down less than 30%. It’s a tough call to make. It depends on your outlook on Europe,” he said.

Europe’s chance

His view on Europe was cautiously optimistic.

“With both the U.S. and the U.K. trying to undermine the global standard, and I mean by that the international economic order, I think Europe has a shot at taking advantage of it,” he said.

“The international economic, financial and global trade order was set after World War II by the Americans with institutions designed by the Americans and with Americans’ benefits in mind.

“We’re dismantling all of that. We’re giving out our advantage in the world trade and on world financial operations.

“These political changes are playing out in the economic sphere. Our global trade deficit is at record highs.”

The U.S. trade deficit in goods in August was at its highest in 14 years, according to a report from the Commerce Department earlier this month.

“The Europeans have an opportunity. I just don’t know how to predict what they’re going to do with it. But Europe is certainly investable. It’s a risk worth taking.”

No cap

The high-paying dividend yield of the underlying helped uncap the performance of the note, he said.

“I’m not sure you could get that type of leverage, with no cap on a five-year note linked to the S&P or even to a worst-of,” he said.

“Unfortunately, five-year, point to point, to me that’s the real sticking point.

“I prefer my liquidity. I like to buy the index fund directly so I can sell whenever I want.”

Long tenor

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, also expressed concerns about the length of the trade.

“It’s five years. It’s a little bit too long,” he said.

“Who knows what’s going to happen in five years? It’s very possible the barrier could breach at maturity with what’s going on in the world. If we’re stuck in this health crisis situation another year or two, I’m not sure you can be overly optimistic. You’re also talking about another presidential Election cycle.”

Barrier

The potential return on the downside was compelling, he said. But there were some limits.

“It’s attractive as long as it doesn’t go down more than 30%. You get that protection and the absolute return, but it has to fall within that range. Otherwise you’re taking a huge loss,” he said.

“It’s great to have the absolute return. You can turn a negative into a positive. But I’m not sure you can easily explain that to people. Somehow it looks a little bit too good to be true.”

Not bullish

Despite the uncapped, leveraged upside return, Chisholm did not see a significant return potential on the upside due to the underlying.

“I’m not very bullish on Europe,” he said.

“I’m not optimistic on the underlying. Europe in my opinion is going to stagnate. I just don’t see a lot of economic growth there. There’s too much going on in the European Union, starting with Brexit. People have been saying that Europe is undervalued. I think Europe is actually overvalued.”

Scotia Capital (USA) Inc. is the underwriter with Goldman Sachs & Co. as a distributor.

The notes priced on Oct. 23 and will settle on Oct. 28.

The Cusip number is 064159XG6.

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