RBC's barrier leveraged notes linked to Euro Stoxx 50 offer value play, prudent bet for bulls

By Emma Trincal

New York, Feb. 7 - Royal Bank of Canada's 0% bullish barrier enhanced return notes due March 1, 2016 linked to the Euro Stoxx 50 index are designed for cautiously bullish or value investors, but the timing of the trade may have to be carefully examined, sources said.

The payout at maturity will be par plus 120% to 130% of any index gain. The exact leverage factor will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 30% and will be fully exposed to losses from the initial level if the index falls below the 70% barrier level.

"It's pretty straightforward. It may work for somebody who is bullish but a little cautious, someone who is worried about volatility; otherwise, you would get less protection and more leverage," said Steve Doucette, financial adviser at Proctor Financial.

"I don't know if the structure is all that exciting, but at least it's easy to explain."

For Christian Wagner, chief executive officer at Longview Capital Management, LLC, the notes may be appropriate as a value play.

"It sounds relatively marketable. I think it makes some sense," he said.

"It's good if you are a value investor and want some downside protection. I wouldn't be selling the farm for the downside protection though."

The most interesting aspect of the structure, those two buysiders said, was the absence of a cap despite the upside leverage and the up to 30% contingent downside protection.

"No-cap deals are hard to find these days, so that's a positive," Doucette said.

"When you start to put a protection and some leverage on the upside, usually that's when they put a cap.

"It's a final barrier, which is good too. It's a point-to-point payout. It doesn't matter what happens in between, so those are pretty interesting features."

A hot market

While the euro zone equity markets have been on the rise - the index has gained 23% in the past eight months - sources were questioning the timing of the trade.

"This deal would've been a heck of a lot more attractive three months ago. We've seen a nice rally in the euro zone in the last three months," Wagner said.

Doucette said that he questioned the durability of the current bull market as stock returns tend to revert to the mean.

"We are now four years into a bull market," Doucette said.

"Bull markets on average last three-and-a-half to four years. It might be good because bear markets are usually short-lived. If we go into a bear market within two years, the index may drop, but it may go back up by the end of the term. However, it's hard to predict what the market will be like three years from now. A three-year term is our maximum.

"I would want to take a look where the average bear-bull market would fall into if I was to execute the trade today.

"This would have been a great note two years ago."

Political risk

More tangible factors are the risks associated with the euro zone countries whose 50 largest stocks constitute the underlying index.

France accounted for 35.3% of the index as of Dec. 31 and Germany for 32.2%. Spain and Italy had a 12.4% and 8% weighting, respectively, or slightly more than 20% together.

"It's a decent bet on Germany, but the remaining countries are risky," Doucette said.

"You have a fifth of this index allocated to Italy and Spain, two countries which are still struggling with their deficits.

"France is a mess. The only one that gives you confidence is Germany.

"I'd be curious to see a note tied to a single-country index or ETF. We don't see one-country-only types of products, but then making a regional call is hard to do as well."

For Wagner, political risk was one of the major challenges investors in European equity may face.

"There is more political risk in Europe than there is economic risk," he said.

"The euro zone is officially in recession. The intermediate macro outlook for the next 12 to 18 months is negative.

"Three years from now, things could be very different, possibly better.

"The biggest risk in Europe is Spain. The Greek exit is priced in. But a Spanish bailout could lead to political anarchy."

Alternatives

Given the nature of the risks and the uncertainty that still lies ahead for Europe, those buysiders said they may think of better ways to get European equity exposure.

"I'd be curious to identify one similar type of product but one tied to Germany. I'd be curious to see what you'd have to give up on the leverage side," Doucette said.

"From a value standpoint, it's not a bad investment, particularly with the leverage," Wagner said.

"Would I do it differently? Sure. I would simply buy a euro-focused ETF and short the weakest economies."

RBC Capital Markets, LLC is the agent.

The notes will price Feb. 25 and settle Feb. 28.

The Cusip number is 78008SYW0.

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