JPMorgan’s barrier leveraged notes on Stoxx, ETF offer long-term bullish bet on Europe, value

By Emma Trincal

New York, Jan. 31 – JPMorgan Chase Financial Co. LLC’s 0% uncapped contingent buffered return enhanced notes due Feb. 29, 2024 linked to the lesser performing of the Euro Stoxx 50 index and the iShares MSCI EAFE exchange-traded fund are attractive partly because of the long duration of the trade, advisers said.

Investors get a significant exposure to the European equity market due to the choice of the Euro Stoxx 50 index combined with an ETF that carries a heavy European weighting, they noted.

The five-year tenor not only provides better terms but also was seen as a way to cut the risk associated with investing at the end of a long bull cycle, one of them said.

If each asset finishes above its initial level, the payout at maturity will be par plus 2.9 times the gain of the worse-performing asset, according to a 424B2 filing with the Securities and Exchange Commission.

If either asset falls but by no more than the 50% contingent buffer, the payout will be par.

Otherwise, investors will lose 1% for each 1% decline of the worse-performing asset.

“Only with a five-year can you get unbelievable terms like this ... a no-cap, three-times up and a 50% barrier. ...,” said Steve Doucette, financial adviser at Proctor Financial.

“You just have to be willing to tie your money up that long.”

Riding the old bull

The length of the trade is actually not an obstacle in his view, especially in the current market cycle.

“We never know when the market will go down or how quickly it may recover once we hit a bear market. What we know is that we should already have had a bear market pullback and we haven’t,” he said.

This is why this adviser said he is not entirely comfortable with shorter-dated notes at this point.

Since August, the U.S. stock market has become the longest bull market on record. In March, it will be 10 years since the end of the bear market of 2008-2009.

“If you buy a two-year or a three-year note right now, chances are you’re going to be stuck in a down market without enough time to recover,” he said.

“Here, you can go through the pullback and capture the recovery later on.

“The market drops and in the final two or three years, it goes back up again. You’re picking up a huge upside with the three times and no cap, and you have time to compound your return.”

Retirement strategy

Doucette said it is unlikely the next bear market will hit later on toward the end of the five-year term. Yet, having the downside protection is a significant advantage.

“It’s a 50% barrier. What are the odds you’re going to hit that 50% five years from now?” he said.

For many investors, a five-year timeframe is a normal holding period, he noted.

“When we do a retirement plan for a client, we’re thinking 30 or 40 years. We use 30 years as a minimum. Our younger clients are in their 40s and 50s, so what’s five years in regard to a 30- or 40-year stretch?” he said.

“It’s a good note for a long-term holding. It’s a simple note. I kind of like products like that.”

High correlation

Matt Medeiros, president and chief executive officer at the Institute for Wealth Management, also found the tenor attractive for macroeconomic and valuations reasons, as Europe needs time to solve some of its political issues.

The high correlation between the two underlyings is helpful in reducing the risk associated with a worst-of note, which increases when the reference assets have a weak or negative correlation, he noted.

“There is a big overlap between the EAFE and the Euro Stoxx. Investing in the EAFE is putting more than half of your investment in Europe,” he said.

The iShares MSCI EAFE fund replicates the MSCI EAFE index, which covers the markets of developed countries. While Japan is the top country for that fund with a 24.31% allocation, the sum of the European countries – both members and non-members of the euro zone – represents about 60% of the portfolio. The United Kingdom, which has a 17% weighting, is the second largest country in the fund.

As a result, the correlation between the two benchmarks is very high at 0.97, with 1 representing a perfect correlation.

Problems take time

“We like the idea of getting into the European region because valuations are very attractive,” Medeiros said.

“The problem is valuations are attractive because there are a lot of headwinds.

“My hope – and it’s more of a hope than it is a financial analysis – is that they’ll figure a lot of things out in the near future.

“So the fact that it is a five-year term is advantageous, I think, because valuations are low and my expectations are that things will improve in Europe over that time,” he added.

Better pricing

A long duration also allows the issuer to offer better terms.

“I like the no-cap, and the no-cap is standard for a long-term deal,” he said.

The contingent protection offered through the barrier is also a plus.

“I’m not a barrier fan, but because this is a pretty low barrier and also because Europe offers value at this time, it doesn’t bother me that much.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes will price on Feb. 25.

The Cusip number is 48130WVD0.

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