Bank of America's 90% protected Mitts linked to Dow fit some conservative clients, but not all

By Emma Trincal

New York, July 30 - Bank of America Corp.'s 0% Market Index Target-Term Securities due August 2018 linked to the Dow Jones industrial average target conservative investors willing to sacrifice long-term returns for near full principal protection, a financial adviser said.

But for others catering to ultra conservative portfolios, the 10% at risk is still too much.

The payout at maturity will be par of $10 plus any gain in the index, up to a maximum return of 45% to 55%. The exact cap will be set at pricing.

If the index falls, investors will be exposed to losses of up to 10%. The minimum payout will be 90% of par.

Upside risk

"Given the time period of the notes, the protection becomes immaterial because the likelihood of any equity benchmark being down over a six-year timeframe is rather slim," said Carl Kunhardt, wealth adviser at Quest Capital Management.

"They're not really taking any risk by fully isolating you," he said about the issuer.

"The greater risk in the notes is the 45% over six years. They're capping you at 7.5% [per year].

"This is for an investor who wants to pay for peace of mind by giving up most of the upside."

Kunhardt based his outlook on research by Roger Ibbotson, who wrote about market returns and founded Ibbotson Associates, now part of Morningstar Investment Management.

"From 1926 to 2006, 20% was the most you could lose," Kunhardt said.

"Sure we had 2008 since then, but supposedly, 2008 is a one-in-a-hundred-years event. Can we have another 2008-type of event in the next six years? Yes, of course. Are we likely to have one? Probably not."

He said that the median annualized return for large caps over a long period of time was about 10%.

Retirees only

However, the notes have a place in some portfolios, he said.

"This may be appealing to a conservative investor who wants to get enough growth to stay over inflation and who's not necessarily bothered to give up some upside," he said.

"But for a client that's in accumulation mode, I don't know if it's a great note.

"It belongs to a retired portfolio, for those who need a little bit of growth, not necessarily market growth.

"In any event, it's still part of an equity allocation. At least, that's where I'd put it."

But the notes would be too risky for other market participants who cater to the most conservative types of investors, said David Hutcheson, head of operations and trading at CD Funding Group, talking about his clients.

Hutcheson noted that recent low interest rates have led investors to get exposure to credit risk.

"With interest rates moving down even further in the last three or four months, we've seen volume shifting away from FDIC-insured products into notes," he said.

"Issuers have higher funding levels for notes, and more people are willing to forgo insurance protection to take on credit exposure. This is an important evolution."

Downside risk

However, even when they move into notes, those clients rarely buy anything but fully principal-protected notes, he said.

On a riskier part of the spectrum, buffered notes typically appeal to affluent investors only, he said.

But notes like this one with a 90% amount of protection would probably be still too risky for his clients, who look at all aspects of risk, he explained.

"On a long-term note and for someone used to the FDIC insurance, the issuer's credit risk becomes an item of importance," he said.

"We did three different deals last month, all fully principal protected, and we used JPMorgan and Wells Fargo. We feel a little bit more comfortable with those names. They trade at tighter spreads.

"Bank of America is a little less desirable than some of the notes we typically get requests for.

"It doesn't mean it is not a good offering. But our clients are just too conservative to take any kind of additional risk.

"It's already a big step to give up FDIC insurance to go into a note. It would be an even bigger step to move from FDIC insurance to downside exposure."

Bank of America Merrill Lynch will be the agent.

The notes are expected to price in August and settle in September.

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