Scotiabank's $46.86 million leveraged notes tied to MSCI EM ETF offer high cap, contrarian bet

By Emma Trincal

New York, Oct. 16 - Bank of Nova Scotia's $46.86 million issue of 0% capped enhanced participation notes due March 31, 2016 linked to the iShares MSCI Emerging Markets index fund was the largest deal of last week. The notes enable bullish, contrarian investors to capture high returns on an out-of-favor asset class, explaining the popularity of the deal, sources said.

If the index return is positive, the payout at maturity will be par plus 1.75 times the fund return, subject to a maximum gain of 40%. Investors will be fully exposed to any losses, according to a 424B2 filing with the Securities and Exchange Commission.

"What's interesting about this one is that it's got no protection and it's a pure bullish play on emerging markets," a sellsider said.

"Emerging markets have taken a hit recently. It's definitely a contrarian view. You're getting rewarded taking out the opposite view."

Out of favor

A market participant agreed, saying that valuations of emerging markets have come down to more attractive levels.

"Emerging markets over the last month or so have just been pretty beaten up," this market participant said.

"I know a couple of firms that have recently said we've reached a point where it makes sense to get in because chances are that we'll see some upside."

The iShares MSCI Emerging Markets ETF has lost 3% this year. It was up 10.5% during the same period of last year.

The bullish view on emerging markets may not necessarily contradict a bullish stance on U.S. markets, he said.

"You can have confidence in both. Yellen has just been [nominated]. She's going to continue the easy monetary policy, which will bode well for the U.S. over the long term regardless of the short-term imagination in Washington," he said.

High cap

"Investors see some opportunities in this asset class. It's a very bullish product," he added.

The bullish nature of the structure is evidenced by the 40% cap, which is about 16% per annum on the two-and-a-half-year term. The absence of any downside protection is another characteristic of the bull play.

"The 40% cap is pretty high," he said.

"Some deals give you the downside protection with a much lower cap. Others will give you, like this one, a more bullish product, no downside protection and a pretty high cap or no cap at all.

"It does vary. In this structure, the bet is that emerging markets have been hit so hard that it doesn't make sense to pay for a downside protection. People would rather take all the upside."

Offshore exposure

The timing of the deal amid last week's gridlock in Washington may have helped the deal too, an industry source said.

"It's the story of having some offshore exposure given what's happening in the U.S.," this source noted.

"Emerging markets have sold off significantly both in FX and equities. It could be a contrarian play.

"We're still in a challenging pricing environment.

"Yields have picked up but are still low. Volatility is still low. It's hard to get a good enough cap, and this one is pretty good.

"If you introduce protection, it sort of kills your cap. Here, they did the opposite. They gave you a pretty decent cap, but you have to give up the protection."

The notes (Cusip: 064159379) priced Oct. 7.

Scotia Capital (USA) Inc. was the underwriter with Goldman Sachs & Co. as dealer.

The fee was 2.125%.

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