Citigroup’s buffer notes linked to ex Japan index, emerging markets ETF aimed at Asia bulls

By Emma Trincal

New York, March 19 – Citigroup Global Markets Holdings Inc.’s 0% buffer securities due March 24, 2022 linked to the lesser performing of the MSCI AC Asia ex Japan index and the iShares MSCI Emerging Markets exchange-traded fund are designed for investors bullish on emerging markets with a tilt toward Asian stocks.

The payout at maturity will be par plus 143.5% of any gain of the lesser-performing asset, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the lesser-performing asset falls by up to the buffer amount of 15% and will lose 1% for every 1% that the laggard asset declines beyond the buffer.

Michael Kalscheur, financial adviser at Castle Wealth Advisors, weighed his concerns about the underlying assets against his strong interest in the terms of the deal.

“Valuations metrics are better overseas, but I get very nervous about the rest of the world. It’s cheap, but it’s going to stay cheap. Like most people, I do allocate to foreign stocks. But the U.S. market just seems to be the best place to put money in my view,” he said.

Normally, worst-of payouts are a concern for this adviser. But in this case, the correlation between the two asset classes is so high that it mitigates a large part of the risk, he said.

“My biggest hesitation is that MSCI Asia index I’m not too familiar with. I don’t have any exposure to Asia, but it’s highly correlated to the emerging markets fund, which I do have exposure to. I would just have to do additional research on the Asia index,” he said.

Unlike the emerging markets ETF, the MSCI AC Asia ex Japan index covers both developed and emerging markets countries. The 11 represented countries are China, Hong Kong, India, Indonesia, South Korea, Malaysia, Pakistan, the Philippines, Singapore, Taiwan and Thailand.

Mostly Asia

But Asia is the dominant region in the offering.

China, South Korea and Taiwan are the top three countries in both assets. Combined, those three countries have a 57% weighting in the emerging markets ETF and 64% in the MSCI AC Asia ex Japan index.

Several Asian countries are present in both underlying assets with similar weightings. For instance, India, which is the fourth-largest allocation in the iShares MSCI Emerging Markets ETF and the fifth one in the Asian index, has an allocation of about 10% in both.

“The top holdings are identical to one another, and the holdings are very similar,” said Kalscheur.

The two underliers show a three-year correlation coefficient of 0.96, according to Morningstar.

“It’s not like the S&P 500 index and the Euro Stoxx 50,” he said.

“The correlation is so high you almost wonder how they can improve the terms using two assets instead of one.

“The answer is probably the low fee.”

Good terms

The fee on the three-year term is 0.25%, according to the prospectus.

“The actual terms are pretty good. Citi is not my first choice, but it’s also not Deutsche Bank.

“It’s got 143% on the upside, uncapped, which I like.”

The leverage was sufficient and the “loss of dividend” relatively modest. Both underliers show a dividend yield of about 2%.

“You’re going to make up for the loss of dividend pretty easily. The index doesn’t need to be up a lot.”

Length

One possible concern was the tenor. Kalscheur tends to invest in longer-dated notes, especially five-year products.

“Three-year is one of the most dangerous time periods, but two-year would be worst,” he said.

He made this assessment using data he collected on the MSCI Emerging Markets ETF since 2003.

“I don’t have data on the other index, but this is just to get an idea,” he said.

The chances of losing money amounted to 28.4% over a three-year rolling period since 2003 versus a probability of 38.8% over a two-year period, he noted.

“Having three years lowers my chances of losses but certainly doesn’t eliminate it,” he said.

“There’s still enough of a chance to lose money that I would want a buffer. I would certainly not be comfortable with a barrier at 15%.”

But overall the terms of the notes were attractive.

“It checks all the boxes: high leverage, no cap, and buffer. The fee is also very good,” he said.

Low fees make a big difference, he added.

“We had a private placement with a 12 basis points fee annually. This one at about 8 bps is a little cheaper, and in fact, I’m surprised how cheap it is. But we found that the lower the fees, the better the terms of the deals.”

A lot to like

Steven Foldes, vice-chairman at Evensky & Katz/Foldes Financial Wealth Management, also had a positive view on the notes.

“There’s a lot to like about this deal,” he said.

He also liked the correlation between the two underlying assets.

“The countries represented do reflect large weightings in both indices. Asia is the dominant component in each. Essentially you’re making a bet on Asia,” he said.

“Having 1.43 leverage with no cap is very nice.”

This adviser prefers shorter notes, preferably with tenors of less than two years.

“Three years is a little bit long, but Citi is a pretty good credit ... better than other U.S. banks such as Morgan Stanley and Goldman Sachs,” he said.

“The fee is a modest 25 bps.”

Bullish bet

“It’s a very interesting offering. You have the leverage, the unlimited upside, the 15% hard buffer. It’s particularly attractive if you look at what’s happening in emerging markets and Asia,” he said.

“Those markets were beaten up last year after a really strong 2017. We’ve seen some bounce-back in the first quarter of ’19, but it’s still at pretty low levels compared to the end of 2017, so you’re getting in at a good price.”

Finally, an end to the “trade war” between the United States and China would send the return higher.

“We do expect there will be some trade deal with China between now and 2022. That ongoing uncertainty has been a deterrent to good performance so far. That cloud in all likelihood will be lifted, which will be favorable to investors in this note.”

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes were set to price on March 20.

The Cusip number is 17326YVK9.

© 2015 Prospect News.
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