Citigroup’s enhanced buffered digital notes tied to Euro Stoxx to fit range bound view

By Emma Trincal

New York, Aug. 31 – Citigroup Global Markets Holdings Inc. plans to price 0% enhanced buffered digital securities due Oct. 1, 2020 linked to the Euro Stoxx 50 index, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes at or above its 85% threshold level, the payout at maturity will be par plus the fixed return of 16% to 19%. The exact fixed return will be set at pricing.

Otherwise, investors will lose 1% for each 1% decline beyond 15%.

Negative trigger

The structure is the most beneficial to investors when the index declines by less than 15% at the end of the three-year period, said Steve Doucette, financial adviser at Proctor Financial.

“If the market is up, you’re capped at 18%. That’s 6% a year. That’s your upside.”

This type of payout would be unlikely to attract bulls, he said. But bears expecting a more severe pullback may be likely to stay away from the product as well.

The digital return is triggered below the initial price at 85%, which is the rationale behind the lower cap, he said.

“But it’s really nice only if you’re down a little, not if you’re up or down a lot.

Unfortunately a small market decline may not be the most probable scenario, he added.

“You may have a 15% buffer; if we have a real bear market you’re still opening up to a lot of downside risk on the equity side.”

Asset allocation

For Doucette the digital return did not warrant taking on such risk. One additional disadvantage was that the notes were more difficult to allocate, he added.

“A 6% return is more like a fixed-income component. But you can still lose 85%. It’s not clear where you would allocate this in the portfolio,” he said.

Alpha source

The real “alpha” offered by the product came from an index decline by less than the buffer threshold, he said.

“If it’s down but not down by more than 15% that’s where you’re really going to outperform. If it’s up a little, like up 5%, you can still outperform but for an equity component, it’s not such a great return,” he said.

Doucette considered that the “window of outperformance,” which is any decline in the index within the buffer zone, was too narrow.

“If you buy this you really have to have the conviction that this index will only go down just a little.

“I’m not sure I would take that bet.

“I’m not really comfortable with the risk-adjusted return here. The chances of outperforming are small.”

Volatility

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he would not consider the notes. Holding a cautiously bullish view, the cap would be too low. At the same time, the buffer size would not be enough for him given the volatility of the underlying index.

“I do like the index. I do like the concept of getting a positive return when the index is negative. This is what makes the product appealing,” he said.

“However, given the volatility of the Euro Stoxx 50 and the term, I think the buffer may be a little too small.”

The implied volatility of the Euro Stoxx 50 index is approximately 13.5% versus 9% for the S&P 500 index.

“The terms are OK but it’s not the type of investment we would jump out to own as something appealing in this asset class,” he said.

Cautiously bullish

For a bullish investor the digital limits too much of the upside in his opinion.

“I wouldn’t want to cap my upside at 16% or even 19% for three years,” he said.

“If I had a lower return expectation for this index, perhaps this would be more appealing.”

Medeiros said he was optimistic about the European benchmark given how its performance has been lagging that of the S&P 500 index for several years.

“Valuations are more appealing in Europe than in the U.S. large-cap market. It’s a valuation play, mostly,” he said.

But while the Euro Stoxx index may show more room for growth on the upside, price moves may also cause greater risk.

“I would basically need more downside protection and a higher cap,” he said.

The notes will be guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes were scheduled to price on Sept. 26.

The Cusip number is 17324CM45.

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