BNP’s leveraged plus notes tied to S&P 500, EAFE, EEM ETFs offer defensive play, core strategy

By Emma Trincal

New York, May 7 – BNP Paribas’ 0% leveraged certificate plus notes due May 29, 2020 linked to the S&P 500 index, the iShares MSCI EAFE exchange-traded fund and the iShares MSCI Emerging Markets exchange-traded fund offer solid downside protection and a diversified asset allocation, sources said.

The S&P 500 will have a 53% weight, the MSCI EAFE ETF a 42% weight and the iShares MSCI Emerging Markets ETF a 5% weight, according to a term sheet.

If the final basket level is greater than or equal to the initial level, the payout at maturity will be par plus 100% to 120% of the basket return. Investors will receive par if the basket falls by up to 50% and will be fully exposed to the basket’s decline if it drops beyond the 50% barrier.

If the upside participation rate is fixed at only 100%, investors will not benefit from upside leverage.

According to a source, when the same BNP product “printed” in March, the participation rate was 110%.

Upside

A market participant said that even if the upside is not leveraged, the deal has very strong features.

“What’s important is that you get at least a one-to-one exposure to the upside and there is no cap,” he said.

The main appeal is the downside protection, which offers a 50% barrier observed at maturity.

“The barrier is really deep, and it’s a European barrier,” he said.

A barrier is called “European” when it is observed at maturity and not during the life of the notes.

Allocation

The underlying basket is another attractive part of the notes, this market participant said.

“The EAFE gives you allocation to Europe. From an advisory side, people like these types of allocations,” he said.

“It’s not solely a bet on American equity but also on the EAFA and emerging markets.”

The EAFE ETF tracks the MSCI EAFE index, which offers exposure to a broad range of companies in Europe, Australia and Asia. European stocks represent more than 60% of this index, according to BlackRock Fund Advisors, the investment adviser to the fund.

Emerging markets

While the United States and developed market countries weightings represent respectively about half of the basket, emerging markets make only 5% of the basket. The market participant said the small weighting is consistent with the stable, conservative nature of the investment.

“Usually emerging markets are driven by natural resources. When the prices of natural resources like oil are depressed, it can affect the performance of those markets. Shares of Brazilian or Venezuelan stocks were seriously impacted when oil prices plummeted. You still need to allocate to emerging markets, but you may not want to over allocate to it,” he said.

Dividends and protection

As with most structured notes, investors are not entitled to receive dividends from the underlying assets.

The dividend yield of the S&P 500 index is 1.9%. The iShares MSCI EAFE ETF has a 3.40% yield, and the emerging markets ETF has a 2% yield.

Based on the weightings, investors have to forgo about 2.5% of dividend yield. Over a period of five years, the opportunity cost is about 12.5%.

“You have to compare the notes versus the ETFs fairly,” the market participant said.

“You may lose the dividend yield, but this is used to pay for the downside protection.

“What if the portfolio goes down 20%? Which one is better? Losing nothing or losing 8%?”

The 8% loss on an ETF portfolio would represent the 20% decline in the basket value minus the cushion offered by the 12% the equity investor would have received in dividends.

“Products have to be compared on both sides,” he added.

“A 50% European barrier is a very defensive protection.

“The allocation, the deep barrier and the unlimited upside make this product very intriguing.

“It would be very hard to reproduce this type of exposure with ETFs. You might get the additional leverage but not the downside protection.”

Core allocation

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he also likes the defensive profile of the product.

“I like the fact that it has such a deep barrier. The probability of breaking it on a point-to-point appears to be pretty minimal,” he said.

“The length of the notes is OK with me.”

The portfolio is also attractive in his view.

“It’s good that the allocations are relatively diversified, especially that half of the weightings approximately are in Europe and emerging markets.

“The fact that you only have 5% in emerging markets is not out of the ordinary in a standard portfolio. It gives you an additional growth opportunity while limiting some of the risk.

“The S&P position will be a nice allocation for the term of the notes. The S&P returns will tend to normalize, and some of the growth opportunities will come from Europe and the emerging markets.

“If the intention of the notes is to build a core allocation strategy, then this would be a pretty fair strategy.

“The part missing in this note would be some sort of bond holding, but with interest rates appearing to be on the rise and likely to be higher, not having that doesn’t bother me.

“This definitely looks like a good alternative to a tactical play.”

The notes are expected to price May 26 and settle May 29.

The exact terms will be set at pricing.

BNP Paribas is the agent.

The Cusip number is 05579TE28.

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