Wells Fargo’s leveraged buffered notes tied to iShares MSCI EAFE aimed at risk-averse investors

By Emma Trincal

New York, July 15 – Wells Fargo & Co.’s 0% leveraged buffered notes due July 31, 2018 linked to the iShares MSCI EAFE exchange-traded fund offer access to developed markets with reduced risk, 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 return of 14%, according to a 424B2 filing with the Securities and Exchange Commission.

This cap is the equivalent of an annualized maximum return of 6.77% on a compounded basis, he said, noting that the fund only needs to rise less than 5% a year in order to deliver this return.

Investors will receive par if the fund falls by up to the buffer – which will be 21% to 26% – and will be exposed to any losses beyond the buffer, with the exact percentage to be set at pricing.

“It’s really a very strong buffer,” said Vile.

“On only two years, 23.5% is a solid downside protection,” he said.

“Obviously, the emphasis is on protection rather than upside return. Investors in the notes want exposure to this asset class but have limited growth expectations. Otherwise, they would not agree to this cap level.

“When you buy this note you spend a lot on the downside protection. If the index goes up a lot, you’re missing on the rally, but capturing top returns was not your goal in the first place. If you’re strongly bullish on the fund, this is not the note for you.”

Diversified exposure

The 17.2% implied volatility of the fund was probably not enough to pay for a large buffer and a high cap at the same time.

“You can’t have it both ways. The investor in this note is risk-averse. You’re not getting much of a return, but you have this massive buffer. And that’s the benefit of the note,” he said.

The investment also offers broad diversification. The EAFE index offers exposure to most developed countries excluding the United States and Canada. Japan captures the largest allocation with a 23% weight and is followed by the United Kingdom at 19.25%. France is third with a 9.6% weighting.

Low risk

Future Value Consultants evaluates risk, return and price using a variety of proprietary scores in order to compare a product with others, including its peers and all products.

The firm calculates the market risk and the credit risk and adds the two components to generate the “riskmap,” which measures on a scale of zero to 10 the risk associated with a product with 10 as the highest level of risk possible.

The notes have a 1.52 market riskmap versus an average of 1.75 for the same product type, according to Future Value Consultants’ research report on the notes.

The product type is leveraged return. This category includes all structured notes with an upside participation rate greater than 100% with or without any protection feature.

“It’s a very low [score] as you would expect. It’s low because the buffer is very strong,” he said.

On the credit side, risk was also very low as evidenced by a 0.28 credit riskmap, compared to an average of 0.46 for the leveraged return category.

“You have a top credit, and the duration is quite short. Not surprisingly, credit risk comes out low.”

Adding the two risk components gives a 1.80 riskmap, compared to an average score of 2.21 for similar products and 2.17 for all products, the report showed.

“The risk profile is very low. This note is for someone who needs to reduce risk as much as possible,” he said.

Return score

The return score measures the risk-adjusted return of a note. It is computed based on the best among five market scenarios. In this case, the score derives from a bullish market assumption.

The return score is 7.35 versus an average of 7.45 for similar products and 7.14 for all products, according to the report.

“The low risk helps, but the 7% a year return doesn’t. You get capped down. A higher cap would have improved the score a lot. It’s still not bad though. It’s in the average,” 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.

At 8.69, the price score is relatively close to the average for the same product type, which is 8.76.

“They spent a fair amount on the options to extract value. For a two-year [note], that amount of buffer with leverage on this highly rated issuer is quite remarkable. The product is priced very competitively,” he said.

Overall

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 notes have an overall score of 8.02 versus an average of 8.11 for the product type and 7.73 for all products.

“While the pricing is quite good, the return score doesn’t help. The note would have scored much better with a higher cap. But for investors who want exposure to this asset class with less risk, the notes offer a decent alternative to a direct investment in the fund,” he said.

Wells Fargo Securities LLC is the agent.

The notes will price on July 26 and settle on July 29.

The Cusip number is 94986RR60.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.