Deutsche Bank's notes tied to MSCI EM offer insufficient reward, protection for volatile play

By Emma Trincal

New York, Nov. 29 - Deutsche Bank AG, London Branch's 0% accelerated return securities due Dec. 11, 2013 linked to the iShares MSCI Emerging Markets index fund present attractive terms at first glance, but given the volatility of the underlying index, too little upside and not enough downside protection limit the value of the deal, financial advisers said.

The payout at maturity will be par plus double any gain in the fund, subject to a maximum payment of 11.5% to 13.5%, according to an FWP filing with the Securities and Exchange Commission. The exact maximum payment will be set at pricing.

Investors will receive par if the fund falls by up to 20% and will be fully exposed to losses from the initial level if the fund falls by more than the 20% buffer.

Downside risk

Steve Doucette, financial adviser at Proctor Financial, said that overall, the risk reward profile was not sufficiently attractive, especially because of the use of a barrier to protect from losses.

"It's unlimited downside and capped upside, not a combination that I like," he said.

"It has no buffer. More and more deals use barriers instead of buffers. Volatility is not there and they can't structure deals very favorably. I understand that. It's true that most one-year notes with a buffer end up having caps that are pathetic, so you have to go out three years to get better terms and this after all is only a one-year. Still, once the index hits the 20% level, you can potentially lose everything; you have no protection and yet you can't do more than 11% on the upside. That's not attractive.

"I wouldn't look at these notes with the barrier-type concept because we use structured notes to outperform the index. Once you breach a barrier, you don't outperform and you get 100% downside exposure, which is really not a risk we're willing to take."

The underlying asset class amplifies the downside risk, he noted because "emerging markets is one of the most volatile indexes."

Matt Medeiros, president and chief executive at the Institute for Wealth Management, agreed.

"You have a protection against a 20% loss, and in theory, that's a lot. But in this particular asset class, 20% is not a lot. We saw more than 20% swings in a matter of 60 days earlier this year," he said.

The emerging markets index fund has a standard deviation of 22, he noted, much more than the S&P's at 15.

"With an index that has such a high standard deviation and in the context of the challenges that emerging markets could face should we not be able to resolve our own issues, the 20% protection is lower than the level I'd like to see as an investor," Medeiros said.

Upside risk

Precisely because the underlying is volatile, bulls may find the maximum return they can get from the notes a little disappointing, those sources said.

Assuming a 12% cap, it would only take the index to post a 6% annualized gain for the notes to hit the cap, said Doucette.

The fund so far this year is up 10%.

"What good does the leverage do there, if you're up a lot? You could easily go up a heck of a lot more than 11%. Look at 2009."

The fund in 2009 was up 60%.

"I guess this is one of those range bound deals not designed for the very bullish investor," he said.

"I don't have a specific view on the emerging markets. It may or may not go up a lot, but if it does, do you really want to risk having to miss out on a rally?" he said.

"I'd rather reduce the leverage in order to increase the cap because I wouldn't want this type of upside risk. You get penalized a lot with this type of cap on emerging markets."

Medeiros said that the MSCI Emerging Markets fund has seen sharp price moves so far this year. "It's a sector that we do believe has growth opportunities," he said.

"I don't think the cap is that attractive. The fund was up significantly in the early part of the year. It's up 10% so far because it has dropped a lot, but if you had bought it in January at 38 and sold it in March at 45, you would've made close to 20%.

"If I own the index long, I can cut the holding period and get out when I want to. I can do much better.

"My biggest objection to this product is that I don't see it as an alternative to owning the shares outright," he said.

The securities (Cusip: 25152RAL7) are expected to price on Friday and settle Dec. 5.

Deutsche Bank Securities Inc. will act as the agent.

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