BMO’s buffered bullish enhanced return notes show positive possible outcomes, attractive terms

By Emma Trincal

New York, Jan. 7 – Bank of Montreal plans to price 0% buffered bullish enhanced return notes due July 31, 2020 linked to the lesser performing of the S&P 500 index and the Russell 2000 index, according to an FWP filing with the Securities and Exchange Commission.

If the lesser-performing index’s return is positive, the payout at maturity will be par plus 150% of the lesser-performing index’s return, subject to a maximum return of 22.5%.

If the lesser-performing index’s return is between zero and negative 15%, inclusive, the payout will be par.

If the lesser-performing index’s return is less than negative 15%, investors will lose 1% for every 1% that the lesser-performing index declines beyond 15%.

Strong economy

Carl Kunhardt, wealth adviser at Quest Capital Management, was upbeat about the notes based on two market scenarios he envisioned. Either way, noteholders would outperform the benchmarks, he concluded.

His rationale was based on the notion that his clients will always be allocated to both U.S. large-cap and small-cap stocks independently of market conditions. The question then became whether it made more sense to be long the S&P 500 and the Russell 2000 or to hold the notes.

“Unless you believe the world is falling apart and want to go cash, which is not something I would do...I don’t time the market, you’re better off holding the notes.”

Kunhardt ruled out a severe economic recession over the short term.

“I’m still very bullish on the economy. Friday’s job report was the latest sign that this economy is still very strong and keeps on growing,” he said.

Muted market

In the first scenario, the market would continue to move upwards despite a persisting volatility.

“If that’s the case, the S&P would be the worst performer,” he said.

The benchmark’s performance would be muted but still positive.

“You can be positive on the market and not necessarily expect outsized returns,” he said.

That’s because volatility would put a lid on positive returns.

This scenario reflected his personal outlook. Kunhardt expects the stock market to generate positive returns but at a much slower pace than in the past few years of the bull market.

“It’s never going to hit the 22.5% cap. If it was a five-year, that’s different. But we’ll be in an election year.

In this mildly bullish scenario with returns tied to the large-cap index, the 1.5x leverage would be an edge for noteholders compared to equity investors.

“In this scenario, the leverage works to my benefit. Anytime the market performance is weak yet positive, the leverage is your friend. The buffer on the other hand is a moot point,” he said.

Market disconnect

In his second assumption – and still ruling out an economic slowdown – one could envision a “disconnect” between the stock market and the economy,” he said.

“Over time, the market is always going to perform in line with the economy. But if I’m going to take the opposite scenario than the one I expect, I would assume a negative outlook for the market despite an economy that’s still performing well.

“The small-cap in that case is going to be my worst performer.

“Because the market is going to be negative, the leverage is now the moot point. What’s valuable is the 15% buffer.”

Kunhardt said investors may have their own idea of how much the Russell 2000 index could drop.

“I will never make the call that it would drop 20% or 25% unless we’re in a recession, which I don’t anticipate within that timeframe,” he said.

Even if the worst-performing index fell into bear market territory, noteholders would still be better off with the buffered notes than stock market investors, he noted.

“Unless you’re in the camp of – I’m going cash only, in both scenarios, the note gives you a better outcome than a long position...even if you’re bearish,” he said.

Breathing room

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said he liked the structure “a lot,” especially the cap.

“These are absurdly good terms, especially on an 18-month, which to me is still relatively short term,” he said.

Usually this adviser avoids worst-of products. But in this leveraged buffered structure with two relatively highly correlated benchmarks, he felt comfortable explaining the notes to his clients.

“Usually short-term notes don’t give you good caps. Here, you’re getting 14.5% compounded on an annualized basis. It’s very generous,” he said.

Attractive caps sometimes may limit downside protection due to pricing constraints, especially on a short-term note.

In this case however, and probably due to the worst-of payout, investors can enjoy both.

“A 15% hard buffer on an 18-month. That’s really good,” he said.

“You still have breathing room on the upside.

“You will outperform by a significant margin.”

Low fee, high correlation

Another positive item was the 0.6% fee as disclosed in the prospectus.

“They’re not taking a big fee and maybe that’s part of the reason why you get such fantastic terms,” he said.

The only downside of the notes would be the worst-of payout, but only if the investor has a very specific, conflicting outlook on the two indexes.

“If you’re a big bull on the S&P and very negative on the Russell, I would say that could be an issue. But you’re really dealing with two of the most popular U.S. equity benchmarks. It’s not like having exposure to an oil producer index and China,” he said.

Overall, Kalscheur said the notes would be a good fit for the growth part of a portfolio.

“I’m hard-pressed to find anything I don’t like about this note.

“We’ll take a look at this one.”

BMO Capital Markets Corp. is the agent.

The notes will price Jan. 28.

The Cusip number is 06367WGJ6.

© 2015 Prospect News.
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