Bank of America's step-up notes linked to MSCI EAFE, MSCI EM offer bullish global exposure

By Emma Trincal

New York, April 30 - Bank of America Corp.'s 0% market-linked step-up notes due June 2014 linked to a basket of two indexes are a good fit for global equity bulls, said Carl Kunhardt, wealth adviser at Quest Capital Management.

"It offers return enhancement potential to mildly bullish investors without penalizing the more aggressive bullish outlook, he said.

"And on the downside, you're not worse off than being long the basket."

The basket consists of the MSCI EAFE index with a 75% weight and the MSCI Emerging Markets index with a 25% weight, according to an FWP filing with the Securities and Exchange Commission.

If the basket finishes above the step-up value - 119% to 125% of the initial value - the payout at maturity will be par plus the basket gain.

If the basket gains but finishes at or below the step-up value, the payout will be par plus the step-up payment of 19% to 25%.

Investors will be exposed to any losses.

The exact step-up value and step-up payment will be set at pricing.

Unlimited both ways

Kunhardt said that he likes the upside potential of the product.

"On the upside, I would use it as a return enhancer. If I'm between zero and the step level, I'm getting this upside bump, and above that level, I get one-for-one exposure to the basket. I am not penalized with a cap," he said.

"As long as I finish positive, I know that I'm going to get at least 10% per year. That's a nice jump if the basket does almost nothing.

"On the downside, I'm not more exposed than if I owned the basket. But my upside is unlimited, so it's relatively fair.

"You see what I don't like are those downside buffers with leverage where I'm exposed to greater risk than a direct investment. Here, I have the same risk as the underlying but not any more risk."

Fee, dividends

Kunhardt said that the 2% fee is "pretty standard," adding that "for 200 basis points, you're getting at least 10% per year if the basket is up at maturity."

As with any other structured notes, investors must forego dividends.

The 12-month yield for the MSCI EAFE index is 3.12%. For the MSCI Emerging Markets index, the dividend yield is 1.88%.

Based on the basket weighting, investors in the notes would give up 2.8% per year in dividends, said Kunhardt.

But for an investor making a bullish bet, the assurance (assuming there is no negative credit event) of getting an annualized return of at least 10% if the bet is correct more than offsets the loss of dividends, he said.

European exposure

"I like it," he said. "The concern for some may be the heavy weighting in Western Europe."

Nearly two-thirds of the MSCI EAFE index is allocated to European stocks.

"When you go international, you want a low correlation to the U.S. Western Europe does not give you a low correlation to U.S. stocks anymore," he said.

But Kunhardt added that he is "not too worried" about the headlines coming from Europe.

"There's been so much noise I think we're immune to it," he said.

"We've already assumed that Greece is going to default. It's a matter of time. We've accepted Italy. Ireland and Portugal, nobody cares really, they're not that big. The only one having an impact on a daily basis is Spain," he said.

Despite the eurozone crisis, Kunhardt said that he is comfortable with the underlying basket because he believes that foreign stocks in developed countries and emerging markets should represent a substantial part of an equity allocation for most U.S. investors.

"International equity should be much more. You'll see 15% to 20% allocation to international stocks at the most in most portfolios. We overallocate to the U.S. The U.S. equity market is 48% of the world capital market. That means that only 48% of your equity portfolio should be in U.S. stocks. That's not what you see. It's everywhere the same. In Germany, the majority of the allocation is in German stocks; same in France. There is a home bias everywhere, it's been proven. So I like a basket like this one that gives you non-U.S., international exposure," he said.

Mild bulls only

Kirk Kinder, financial adviser at Picket Fence Financial, said that the notes are a good fit for modestly bullish investors only.

"If you expect at the end of the two years a modest level of growth, this may not be a bad deal because you're leveraging a mild or shallow performance," he said.

"If the basket is up 5% at maturity, you get 20%. It's not bad. That's the positive part.

"Beyond that, if the performance is above the [step-up value] or inversely if it's negative, you would be better off investing directly in the two funds because your cost would be lower, you would realize the dividends and it would remove part of the risk, which is the credit risk."

Kinder also sees in the basket an ordinary international allocation.

"People will overallocate to the developed EAFE index and put a smaller portion into emerging markets. I don't think it's unusual. As an investor, I prefer emerging markets because I believe they have more potential for growth. But the basket here represents a pretty normal allocation to international equity. Nothing wrong about it," he said.

Bank of America Merrill Lynch is the agent.

The notes are expected to price and settle in May.

The exact terms will be set at pricing.

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