BMO’s leveraged notes linked to Energy Select Sector SPDR offer bullish bet on oil stocks

By Emma Trincal

New York, Feb. 5 – Bank of Montreal’s 0% buffered bullish enhanced return notes due Feb. 28, 2018 linked to the Energy Select Sector SPDR fund are designed for bullish investors who expect oil and gas companies to recover from the current bear market in the oil sector, said Tim Vile, structured products analyst at Future Value Consultants.

The payout at maturity will be par plus 150% of any fund gain, up to a maximum settlement amount of $1,300 for each $1,000 principal amount of notes, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the fund falls by up to 10% and will be exposed to losses beyond 10%.

“The cap is very attractive. Investors can get up to 30% over two years. On a compounded basis, that’s a 14% annualized return. The underlying fund still has to move somehow. You need a 9.55% annual return to get you to the cap. It’s not a small increase. That’s why the notes are really designed for bulls,” he said.

Bullishness and confidence are both necessary to invest in a product that gives exposure to a sector in turmoil, such as oil and gas, he said.

The Energy Select Sector SPDR fund tracks the stock performance of large U.S. oil and gas companies.

The ETF has lost 30% in the last 12 months and is down nearly 8% for the year.

“The fund has not performed well. There is a lot of movement. The chances of hitting the 10% downside threshold are fairly high,” he said.

“This is a bullish note in the sense that you can achieve a high return potential. It also gives you some protection but not much when you consider the underlying asset. This stock fund can easily breach the 10% level.

“Investors in this note need to be confident in their call.”

Future Value Consultants rates products based on risk, return and value using a variety of proprietary scores.

The firm compares notes with others in the same category as well as with all rated products.

The product type for these notes is leveraged return. This category includes all notes with an upside participation rate greater than 100% with or without downside protection and capped or uncapped on the upside.

Market risk

The riskmap score for the notes is 5.22 versus an average of 4.16 for products of the same type, according to Future Value Consultants’ research report.

The riskmap measures the risk of a product on a scale of zero to 10 with 10 as the highest level of risk possible. It is the sum of two risk components, market risk and credit risk, which are both calculated on the same scale.

“You have to be reasonably tolerant for risk. The lower entry points are a good incentive to invest, but this index can still drop further. Having a buffer is good as well, but whether it’s sufficient remains to be seen,” he said.

“What helps here is the good score on the credit risk scale. Unfortunately, the market risk is quite high.”

The market riskmap is 5.03, which is higher than the average 3.65 market riskmap for leveraged notes and 3.75 for all products.

“We could have expected a better score given that after all, the notes provide some protection. But at the same time, this asset class is in [a] deep bear market,” he said.

The notes have a 0.19 credit riskmap while the average for the product type is 0.51.

“This is pretty normal. It’s a two-year only, which reduces credit risk exposure. Also Bank of Montreal has very good credit ratings. There’s no reason not to have a good score here,” he said.

Return score

With its return score, Future Value Consultants measures the risk-adjusted return of each product. The score is calculated using various key market assumptions. The best of the five scenarios is selected to measure the risk-adjusted return on a scale of zero to 10.

At 6.47, the return score is lower than the 7.45 average for the same product type.

“Of course the higher risk level is what drags the score down. But it’s not bad. The cap is still reasonable,” he said.

Value

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The notes have a 5.25 price score versus an average of 7.67 for the product type.

“The price score is quite lower. What comes to mind is the short duration. There is less time to amortize the fees. That’s one thing. Also more money could have been spent on the options to improve the terms a little bit,” he noted.

Overall score

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

The overall score is 5.86 versus an average of 7.56 for similar products and 6.71 for all products.

“There is a significant difference here. It’s mostly due to the lower price score. The return score is below average but not as much [as] the price score,” he said.

“It’s a balanced structure. You get everything on both ends: protection on the downside and gearing on the upside. The cap is not too punishing. In fact it’s quite good at 14% per year. But the buffer size could have been greater. The gearing may not be enough. One of those two terms if changed could have improved the score quite significantly,” he said.

BMO Capital Markets Corp. is the agent.

The notes will price on Feb. 24 and settle on Feb. 29.

The Cusip number is 06367TAL4.

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