BMO’s notes linked to Raymond James quality yield stock basket offer access to popular sector

By Emma Trincal

New York, Sept. 12 – Bank of Montreal’s notes due Sept. 28, 2018 linked to a basket of 22 equally weighted stocks selected in September by Raymond James & Associates, Inc. offer investors access to one of the best-performing types of stocks in the market selected by Raymond James.

High-dividend stocks both in the small- and large-cap categories have outperformed non-dividend stocks since February 2014, according to research by Credit Suisse.

But financial advisers said the cost of the notes is too rich and pointed to available alternatives.

Selection

Raymond James’ objective was to select securities included in the S&P 500 index that have dividend yields higher than the index constituents as a whole, could sustain or increase their dividend and had credit ratings considered lower medium grade or higher, according to a 424B2 filing with the Securities and Exchange Commission.

Raymond James also sought to produce a basket that, based on historical experience, would be likely to suffer less price volatility than the S&P 500 components as a whole.

Participation

Investors may get a variable coupon paid quarterly. Interest, if any will equal the sum of the dividend amounts for each of the reference shares multiplied by 96.75%.

At maturity, investors will receive $1,000 multiplied by 96.75% multiplied by the basket return, whether positive or negative.

As a result of the 96.75% participation rate, the basket gain must exceed 103.36% in order for investors to receive par back.

Raymond James brokers will get a 2% commission as Raymond James is acting as a dealer, according to the prospectus.

It’s the second Bank of Montreal note linked to a basket of high-yielding stocks selected by Raymond James & Associates, according to data compiled by Prospect News. The first note was linked to a different basket and sold in April for $27.5 million.

Rich

Jerrod Dawson, director of investment research at Quest Capital Management, said he would not consider the notes.

“We would need to be more familiar with the 22 stocks. But it seems like a pretty rich endeavor. With no leverage, no downside [protection] and 96.75% of the return if the basket price goes either up or down ... I don’t really see a benefit to it,” he said.

The prospectus in its hypothetical payments page provides some examples in a table.

If the basket for instance shows a 40% positive return at maturity, investors will only receive 35.45%. If the basket is down 10%, investors will lose 12.925% instead of 10%.

Diversification

The merits of this note will entirely depend on Raymond James’ ability to pick the right stocks, said Dawson. Even if it were the case, he objected to several aspects of the deal.

“For an adviser, having to pay a 2% fee on a two-year in addition to having to hit this 103.36% threshold to just break even, I think is a lot,” he said.

The small size of the basket is also a concern.

“Assuming that these are some of the best stocks, you still have a pretty concentrated portfolio with only 22 names.”

Crowded trade

Finally, he pointed to red flags concerning the valuations of these types of stocks driven by investors’ hunt for yield.

“Most dividend stocks are pretty rich right now. People have been bidding on those names, but it’s beginning to feel like a pretty crowded trade.”

A research report issued last week by Credit Suisse’s U.S. strategy group stated that high-dividend yielding names are hitting new highs on forward P/E multiples, warning that this trade appears to have lost some momentum recently.

“I wouldn’t want to incur an extra cost for a concentrated portfolio of highly valued stocks,” Dawson said.

Cut on dividends

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, raised a similar objection regarding cost. He also is “skeptical” about equity research provided by Wall Street firms.

“To me it looks expensive. For two years you’re paying 3.36%, and on top of that you’re taking a cut on your dividends. I wouldn’t be comfortable investing in some of those picks, especially energy stocks because I think it’s still early to start bottom-picking off the energy sector,” said Chisholm.

This adviser added that “many other investments” are available to investors, especially exchange-traded funds.

Alternatives

“I can easily buy an ETF that would be much cheaper. It would give me liquidity. I wouldn’t have to hold the notes for two years,” he said.

As an example, he pointed to the Cambria Shareholder Yield ETF, which includes stocks providing a high “shareholder yield.” The fund’s total assets are $126.6 million.

“I just think these notes are really expensive for something you could do a lot cheaper on your own, like buying the stocks outright.”

He added that he doesn’t have “a lot of faith” about financial services firms that offer both research and investment banking “under the same umbrella,” arguing that there is always potential for conflict of interest or bias.

Different audience

Other sources had a more positive take on the notes.

“This is not some institutional business,” an industry source said.

“It’s all about bringing high-quality research to a broader audience – not just the top tier high-net worth clients. Of course the top clients are going to have many more avenues and much lower costs for all investments.”

A market participant conceded that the notes are expensive, but he underlined some significant benefits for small individual investors.

“I don’t want to say that it’s cheap,” given the 3.36% breakeven, which is “definitely an additional cost” on top of the 2% commission, he said.

“And yes, you can find alternatives out there that may be more cost-efficient, but I think there’s a niche or market segment where this may be appropriate. Raymond James brokers have a broad spectrum of clients. They have very rich clients, and they have clients with limited funds.

“Raymond James equity analysts have a very good reputation based on their long-standing track record in stock-picking.”

Smaller accounts

The notes are designed for smaller investors who want access to Raymond James’ equity research, he said, adding that “it’s something you can’t find in an ETF.”

“If you want to buy the 22 stocks yourself, you need assets,” he said.

He offered the following example: An individual investor with only $5,000 to invest would have to pay about $10 per trade with a discount brokerage. For 22 stocks, buying would cost $220 and selling would be the same. Overall, commissions would add up to $440.

On a $5,000 notional amount, the $440 cost for these transactions would be nearly 9%.

“Nobody is going to invest $1 million to buy this product because they can replicate it themselves buying the individual stocks,” he said.

“But for someone who wants access to a Raymond James’ research on a specific sector, you can realize a decent economy of scale.

“I don’t see anything wrong with that. This is for the little guy, for people who don’t have tons of money to put on the table.”

The basket

The underlying stocks are AvalonBay Communities, Inc.; Boeing Co.; BB&T Corp.; Cisco Systems, Inc.; CSX Corp.; Chevron Corp.; General Electric Co.; General Mills, Inc.; Johnson Controls, Inc.; JPMorgan Chase & Co.; Coca-Cola Co.; Lockheed Martin Corp.; Altria Group, Inc.; NextEra Energy, Inc.; PepsiCo, Inc.; Pfizer Inc.; Procter & Gamble Co.; Qualcomm, Inc.; Schlumberger Ltd.; Simon Property Group, Inc.; AT&T Inc.; United Parcel Service, Inc.; Verizon Communications Inc. and WEC Energy Group, Inc.

Prior baskets

Raymond James has put together several stock baskets before composed of its own picks in various sectors or groups such as sustainability stocks, financial services, oil stocks and housing as well as baskets of closed-end funds.

Bank of Montreal along with Bank of Nova Scotia and Toronto-Dominion Bank have each used some of these sector-oriented baskets as underliers for structured notes.

BMO Capital Markets Corp. is the agent.

The notes will settle Sept. 30.

The Cusip number is 06367TKV1.

© 2015 Prospect News.
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