JPMorgan’s leveraged buffered notes tied to EAFE ETF have cap one can live with, advisers say

By Emma Trincal

New York, Nov. 16 – JPMorgan Chase & Co.’s 0% capped buffered return enhanced notes due Nov. 24, 2017 linked to the iShares MSCI EAFE exchange-traded fund offer investors a 15% buffer, 1.2 times upside leverage, a short-dated maturity, which, buysiders said make the cap range a fair price to pay for the relatively good terms.

The cap will be set at pricing between 20% and 25%, according to an FWP filing with the Securities and Exchange Commission amending a prior term sheet.

“Usually I’m not a big fan of caps, although I understand that it’s the price for getting a buffer. I get that. But in this particular case I don’t care because I would be happy to get 12% a year from this asset class,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

“When you look at Europe and what happened this weekend ... we already know the economy is already soft. This is going to slow down trade, and whenever you slow down trade, it costs money. This is certainly not going to help the economy.

“So I don’t feel penalized by a 12% cap.”

He was referring to the terrorist attacks that occurred in Paris on Friday.

The MSCI EAFE index tracks the equity performance of developed markets excluding the United States and Canada.

European overweight

The iShares MSCI EAFE fund allocates more than 60% to European countries, according to the iShares website.

“The 60% weighting is unbalanced. But when you think of it, the developed markets are basically Europe and Japan,” he said.

Japan represents the top geographic exposure by country with slightly less than 25% of the fund.

“Where else can I go? You may rule out Africa and the Middle East.

“In South America they’re mainly emerging markets with the exception of Brazil that’s approaching developed status. But they’re being hurt right now by the drop in commodity prices.

“Mexico is tightly correlated to the North American market with NAFTA.”

In Asia, there is South Korea, “but like Brazil, they’re not quite there yet,” he said.

“So if you exclude Africa, the Middle East and South America, you’re going to be overweighed Europe.”

Core holding

Kunhardt said that even if his outlook on Europe is not overtly bullish, he would still invest in this part of the world because “any portfolio should have international equity, and Europe is a big part of it.”

He said he already has positions in the iShares MSCI EAFE ETF as well as in another iShares fund, the iShares MSCI EAFE Minimum Volatility fund, which picks the less volatile stocks from the EAFE index.

“I’ve used the EAFE fund numerous times, but we’ve also added the low-volatility version of the same fund as a defensive move,” he said.

He said that he uses “passive investing” for his core holding and active managers when he wants to get additional performance or less risk.

“But for international allocation, I would use EFA or the low-volatility EFA fund as my core.”

“EFA” is the ticker symbol for the iShares MSCI EAFE ETF.

Painless cap

For investors with a moderately bullish view on international equity, in particular Europe, the risk-reward profile of the notes would be advantageous, he added.

“You’re not losing a lot, and you mitigate risk with this 15% buffer,” he said.

“It’s not going to cost me an enormous amount of return, and by the way they’re giving me a little bit of juice with the leverage.

“Does the cap really hurt me? It depends on your economic outlook. For me, the answer is no.

“The cap doesn’t bother me at all because I would be happy with 12% based on my outlook.”

Caps trending up

Michael Kalscheur, financial adviser at Castle Wealth Advisors, was also pleased with the cap range.

“The 15% downside protection is a buffer, not a barrier. I would love to see it bigger, but on such a short-term note, it would be unrealistic,” he said.

“It’s geared on the upside up to the cap.

“And the cap is actually very good.

“I’ve noticed that caps have improved lately, especially on two-year notes. Not so long ago you would have expected a high cap or no cap only starting from a four-year product.

“This is why I was actually not buying short-term notes. The caps were too low.

“I’m surprised to see how they’ve been able to raise caps on shorter notes. I guess the recent volatility pick-up may have something to do with it.”

Credit, dividends

He said that he liked the creditworthiness of the issuer and that the underlying was one of the best-known funds in the international arena.

“It’s kind of the S&P of the international world, although it is a little bit more concentrated,” he said.

The ETF has 919 holdings, according to iShares.

“There is no U.S., no Canada. It’s heavily allocated to European stocks. Hopefully it’s more stable than the emerging markets fund.”

The ETF carries a 2.75% dividend yield, which is more than the 2% yield associated with the S&P 500 index, he noted.

“You’re giving up a little bit more,” he said, referring to the fact that investors in structured notes are not eligible to receive dividends the way shareholders are.

“You’re giving up three-quarters of a point worth of dividends compared to the S&P,” he said.

“But the higher the dividend, the better the terms logically since you have more money to play with.”

And the terms were indeed “good,” he said.

Winning probabilities

Kalscheur said he runs his own decision tree when selecting a note.

“I always want to win two out of three times.

“Well let’s see this one ... if the fund is down, I’m ahead. I have the buffer. I win.

“If the fund ends up higher but not that much higher, I win too. I’ve got the leverage on the upside.

“It’s only when the market is way, way up that I’m not going to perform as well. But I’d be pretty happy with an 11% or 12% annualized return.

“I like the idea that at least you have a high enough cap so if you do cap out, you’re not going to be disappointed by the return that you get.”

International exposure

Regarding the asset class, Kunhardt said he would make sure to let his clients know about the fund’s overweight in Europe.

“While it’s not a European fund, you’ve got to be somewhat bullish on Europe,” he said.

The notes could be useful for some investors seeking allocation to international equity.

“I’m always a proponent of international diversification. If you have a client who wants international exposure but who’s hesitant to put money there, this would be a viable option,” he said.

“Europe has underperformed the U.S. for some time, and international markets have also underperformed.

“For someone looking for a contrarian yet conservative play, this is a decent way to dip your toe into the international markets.

“It’s not the best deal I’ve ever seen, but it’s a fairly nice offering.”

J.P. Morgan Securities LLC is the agent.

The notes will price on Thursday and settle Nov. 24.

The Cusip number is 48128GDF4.

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