Bank of America's Mitts tied to Dow-UBS Commodity offer timely, low-risk way to play rally

By Emma Trincal

New York, March 4 - As investors put money into commodities again, Bank of America Corp.'s 0% Market Index Target-Term Securities due April 2020 linked to the Dow Jones-UBS Commodity Index - Excess Return may enable those who seek exposure to the rallying asset class to do so in a conservative way, sources said.

The payout at maturity will be par of $10 plus any gain in the index, up to a maximum return of 50% to 60%. The exact cap will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

If the index falls, investors will receive par.

"For somebody who's optimistic that inflation and commodities prices will both rise over the next six years, that deal would make sense," said Tom Balcom, founder of 1650 Wealth Management.

The notes appear timely in light of the recent appreciation of the underlying index, he noted.

2014 rally

"Commodities prices have rallied a lot this year. Prices are up because at some point, the losers become the winners," he said.

"This rally is part of investors rebalancing their portfolios to take advantage of an undervalued asset class, which is what happened last year. But this year's story is quite different."

The Dow Jones-UBS Commodity Index - Excess Return has gained 8.65% so far this year, compared with only 1.4% for the S&P 500.

Last year, the commodities benchmark dropped by 11% while the S&P 500 index soared 32%.

Buy low, sell high

"Advisers have told their clients to rebalance and move money into commodities, which last year was the underweight, undervalued asset class. They're advising their clients to buy low and to sell high, to buy commodities and to reduce their equity exposure," he said.

"Our clients are asking about commodities. Equities surged last year, and commodities performance was down. We have a 10% exposure to commodities. Hopefully, investors are going to grow more confident about commodities this year."

The structure of the notes has "pros" and "cons," he said.

Pros and cons

"The big selling point of this note is obviously the principal protection. It's good for the client to know that a decline in the index is not going to make them lose money," he said.

"Among the cons you have the no leverage. You also have the opportunity cost. Inflation and commodities are correlated. The underlying bet investors are making is that if inflation increases, commodities could perform pretty well. But if the returns are flat and if they have to hold this for six years given the reduced liquidity, they may complain about the opportunity cost, wishing that they would have put their money elsewhere."

The upside is capped, but Balcom said that he is comfortable with the 50% to 60% level over six years.

"It's in the high single digits annualized, and that's not bad. I'm not too worried about being capped out. You're hedged for inflation there."

Hedging volatility

Donald McCoy, financial adviser with Planners Financial Services, said the notes offer the advantage of protecting investors against wide price moves in commodities.

"It sounds like a good deal for people who want to get the commodities exposure to diversify with no downside risk," he said.

"You're still looking at Bank of America from a credit risk standpoint.

"If you were long this index, you would have been up 25% over the last five years. But keep in mind that over the past three years, you would have lost 22%.

"Given the volatility that's inherent in commodities, being able to get some exposure while protecting your principal from market risk would be a positive opportunity for clients."

Some of the reasons behind the recent commodities rally are related to extreme weather conditions, some sources said. But taking advantage of the attractive valuation of the oversold asset class is perhaps the main driving factor behind the rally, McCoy said.

Value play

"We've seen gold perform very well since the beginning of this year," he said.

The precious metal was in bear market territory last year, down 27%. This year, gold has gained 11%.

"People are realizing that gold is oversold. They see the opportunity, and they're going back into it. Gold is now rebounding tremendously," he added.

"But other commodities are rallying too. Natural gas is up. There is continued optimism around energy as being an undervalued sector.

"So when you get these categories of commodities doing exceptionally well, it certainly helps explain why the asset class is now outperforming the equity benchmark.

"Finally, equities themselves, which did so well last year, have been flat so far this year until [Tuesday]."

In January, the S&P 500 fell 3.75%, but February saw the benchmark jump 4.5%.

The index closed up 1.53% on Tuesday alone after tension eased in Ukraine, giving back the losses seen the day before amid an escalation of the crisis between Russia and Ukraine.

Low-risk opportunity

"Equities are flattish for the year. Gold spiked tremendously on Monday. You get that perfect timing for the beginning of this year for commodities to outperform," he said.

"But if you go back 12 months ago, it was not that great. All that performance has been captured in the last two months.

"It's impossible to say whether this bump in commodities is going to be long-lasting.

"Once people stop focusing on geopolitics, they will become bullish on equities again. They will see stocks as a pretty good place to be, in which case you could see commodities underperforming, but this is purely hypothetical, and there is no way to predict anything short term, let alone six years from now.

"For people trying to get exposure to commodities, this is a very low-risk opportunity for them.

"I don't think you're going to see a major reallocation out of equities into commodities, but for those who do want to take on commodities exposure, this note looks like a good option."

BofA Merrill Lynch is the agent.

The notes will price in March and settle in April.

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