JPMorgan’s autocallables tied to Euro Stoxx, iShares EM seen as complex, but yield is ‘decent’

By Emma Trincal

New York, June 18 – JPMorgan Chase & Co.’s autocallable notes due June 21, 2018 linked to the lesser performing of the Euro Stoxx 50 index and the iShares MSCI Emerging Markets exchange-traded fund are designed for income investors seeking an attractive substitute for a fixed-income instrument, said Steve Doucette, financial adviser at Proctor Financial. But risks and complexity are some of the drawbacks, sources said.

“We use these autocalls pretty often to reduce interest-rate risk and find an alternative to fixed-income instruments. The 12.45% coupon is pretty neat, ” Doucette said.

The notes will be called at par plus an annual call premium of at least 12.45% if each component closes at or above its call level on June 27, 2016, June 19, 2017 or June 18, 2018, according to an FWP filing with the Securities and Exchange Commission.

Step down

The call levels will be 100% of the initial levels on the first call valuation date and 90% of the initial levels for the second and third call valuation dates.

The payout at maturity will be par unless either component finishes below its 70% trigger level, in which case investors will be fully exposed to the decline of the worst-performing component.

“The declining call level, I haven’t seen that. I don’t know how you would call it, but it’s kind of interesting. The market can drop a whole bunch and come back and you would still collect the coupon,” he said.

The 12.45% call premium on the first call date, 24.90% on the second and 37.35% on the third is “much higher than what we usually use,” he said.

“It’s a reflection of the risks you’re taking.”

Correlation, volatility

The worst-of payout is one important risk factor. As disclosed in the prospectus, the return and repayment of principal are not linked to a basket of underlying components but to the performance of each underlying component. The less correlated the two underlyings, the riskier the structure, the prospectus said.

For Doucette, however, the main risk is the introduction of a volatile underlying asset class.

“You have the emerging markets in there. Emerging markets could be very volatile. That’s my only concern. You could have a large pullback and get easily caught upside down,” he said.

To reduce the risk, some of the terms may have to be changed, he said.

“I might revisit the barrier and make it more protective. I may want 40% instead of 30% and give up some of the coupon in exchange.

“As it is right now, the risk is hefty.

“It’s definitely designed to be a fixed-income substitute. The advantage is that if interest rates go up, it may not affect you at all. On the other hand, you’re taking on a lot of risk by replacing the interest-rate risk with equity risk.”

Doucette said he would need to do some “due diligence” to study the performance of the respective underlyings.

“The Euro Stoxx has been creeping up along with emerging markets. But I can’t say without doing some research what type of correlation you have, and that’s something you need to look at.

“To me the main factor here is the high volatility of emerging markets. It could really bring down the return since the note is tied to the worst performer.”

Despite the risks, Doucette concluded on a positive note.

“It’s a neat note for fixed-income replacement. It pays a decent coupon. The three-year term if you’re not called before that is pretty standard. I like that three-year window. You could be down and finish up.”

Overwhelming

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said the notes are designed for income-seekers who hope for an early redemption in order to pocket the call premium.

But the terms of the structure are too difficult to explain to most clients, he said.

“I like the idea of creating a structure to produce yield. However, you begin the conversation with the notion of a worst-of. If in the course of that explanation the process is unnecessarily complicated, it becomes a challenge to understand the investment. I do like the underliers, but the structure is too cumbersome,” he said.

“You’ve got the call. You’ve got the worst-of. You’ve got the correlation. You’ve got the step down for the call thresholds. That’s a lot of moving parts.

“Obviously, the potential 12.50% yield is the attractive part. But in the meantime, you have to explain the structure and manage the two underliers.”

Medeiros said he understands that the product is designed to generate a competitive yield.

“I understand the intention. I don’t fault the intention. But the intention could be lost in translation before execution,” he said.

“By the time you get through the explanation of each term, the complexity of the product is just overwhelming.”

J.P. Morgan Securities LLC is the agent.

The notes will settle on Tuesday.

The Cusip number is 48125UXS6.

© 2015 Prospect News.
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