Wells Fargo’s $1.8 million notes tied to iShares MSCI EAFE offer alternative to long exposure

By Emma Trincal

New York, Jan. 31 – Wells Fargo & Co.’s $1.8 million of 0% market-linked securities with leveraged upside participation to a cap and fixed percentage buffered downside due Jan. 31, 2019 linked to the iShares MSCI EAFE exchange-traded fund provide investors with a more conservative alternative to an outright position in the fund, buysiders said.

The payout at maturity will be par plus 200% of any fund gain, up to a maximum return of 26%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the fund falls by up to 10% and will lose 1% for each 1% decline beyond 10%.

Tradeoff

Noteholders make two main concessions: they give up any upside above the cap and forgo the dividends. In exchange they have two-times exposure to the upside and a 10% buffer on the downside, said Tom Balcom, founder of 1650 Wealth Management.

“I think it’s good. If you want short-term exposure to EFA, it reduces some of the risk. You get a 10% buffer. It’s not geared, which is nice. Clients usually prefer a regular buffer like this one.”

The fund is listed on the NYSE Arca under the ticker “EFA.”

The MSCI EAFE index, which the ETF replicates, tracks the performance of equity markets in developed countries at the exception of the U.S. and Canada. Portfolio managers frequently use it for their international equity allocations. Balcom said he has exposure to the iShares MSCI EAFE ETF himself within his international bucket, which represents 20% of his portfolio.

Yield

The fund pays a “high” dividend of 3% a year, he noted.

“You’re losing 6% over the two-year but you’re getting it back in the pricing,” he said.

“They’re giving you those pretty attractive terms because of the dividend. That’s how they can price it.”

The “attractive” terms included the “relatively high” cap over a short period of time.

The 26% cap is the equivalent of a 12.25% compounded annualized return.

“Getting this type of return on a two-year plus the buffer plus the leverage is actually pretty good. You’re giving up something, but it’s a tradeoff.”

Leverage

Balcom viewed the two-time leverage as a way to partially offset the “loss” of dividends.

“I always look for at least two times leverage because it compensates you for not receiving the dividends,” he said.

The leverage may not fully offset the opportunity cost however.

“But it helps. It depends on the price return. If the index is not up a lot, the notes will underperform there.”

For instance, a 5% price return over the two-year period would generate an 11% total return for an equity investor, as it includes the 6% dividends, he explained. The notes on the other hand would slightly underperform providing a 10% gain as the dividends are missing.

“At least the two times provide some level of compensation. The index performance would have to be pretty muted for the notes to underperform on the upside,” he said.

Given the choice between the underlying ETF and the notes, Balcom said he would opt for the notes.

“I always prefer a portfolio hedged as much as possible. You can’t forecast one year, two year or even one day or one month,” he said.

Range bound

Jack Ablin, chief investment officer at BMO Private Bank, may not necessarily prefer the notes to the ETF. But the structured product could be a better solution for a conservative investor, he noted.

“It’s a decent note for someone who wants exposure to international but is somewhat concerned,” he said.

Ablin also noticed the high dividend yield on the underlying causing investors to miss the 6% dividends.

“But it’s a fair structure.

Investors expecting wide price moves in the underlying price would not be interested in the deal, he added.

“Anyone who buys is selling a lot of volatility. If it goes up a lot or down a lot you lose.

“They would assume the market would go incrementally higher, which may be true.”

But he would not necessarily use the notes himself, although the structure is “consistent” with the view of some of his clients.

“My preference would be to own the ETF outright. But it’s a good structure for investors who are cautious,” he said.

Wells Fargo Securities, LLC is the agent.

The notes (Cusip: 94986R3S8) priced on Jan. 26.

© 2015 Prospect News.
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