Bank of Montreal to price two issues tied to iShares MSCI EAFE designed for range bound views

By Emma Trincal

New York, Oct. 13 – Bank of Montreal has announced the pricing of two note offerings with similar maturities, underlying and tenors. The difference in the terms is designed to capture the interest of various types of investors who need to express slightly nuanced views on the asset class, buysiders said.

The notes are linked to the MSCI EAFE exchange-traded fund, which tracks the performance of large and mid-cap developed market equities, excluding the United States and Canada.

Both notes are two-year products with the same maturity date of Oct. 31, 2018 set to price later this month on the same day, according to 424B2 filings with the Securities and Exchange Commission

Absolute return

The first offering consists in 0% contingent risk absolute return notes with a one-to-one upside exposure to the fund. Investors benefit from the product if at maturity the fund return is negative but within a range.

If the fund finishes above the initial level, the payout at maturity will be par plus the fund gain.

If the fund falls, but the fund level has never fallen below the barrier level during the life of the notes, the payout will be par plus the absolute value of the return up to a maximum return of 30% to 34%. The barrier level is expected to fall between 66% and 70% of the initial fund level and will be set at pricing along with the exact maximum return amount.

Otherwise, investors will lose 1% for every 1% decline.

Developed markets

“I like the index,” said Matt Medeiros, president and chief executive of the Institute for Wealth Management.

“I think there are opportunities in this asset class. That’s why I like the fact that there is no cap on the upside.”

About 61% of the MSCI EAFE fund falls into the European country category, which includes members and non-members of the euro zone. The U.K. for instance is the second largest country allocation with an 18% weighting. Japan is the first one, with 24%.

“I am bullish on the EAFE index. This asset class has good valuation and growth potential,” said Medeiros.

“But this is also an index that has potentially substantial headwinds. We’ve got the Brexit. We’re not sure how that’s going to affect Europe. We now have significant currency swings.

“That’s why I like the absolute return. I can get my money back in a negative investment experience.”

To be sure, the barrier must not be breached in order to capture the absolute return. The observation of the barrier on a daily basis makes the product riskier than if it was observed only at maturity.

For bears

Steve Doucette, financial adviser at Proctor Financial, said the notes were more directional than it appears at first glance.

“It’s obviously bearish. The upside doesn’t give you anything more than the price return. Why buying the notes in this case?” he said.

“But you can significantly outperform on the downside if you’re in that negative range above the barrier.”

The fact that the barrier was observable on any day during the term reduced the likelihood of getting the absolute return however. It also limited the range of potential investors, he noted.

“You have the possibility of outperforming spectacularly. But you’re long the index otherwise. It’s probably designed for bears but you can’t be too bearish otherwise you lose the protection and the absolute return.

“And that can happen anytime.”

Leveraged buffered

The other deal, which was named “buffered bullish enhanced return notes,” provided at maturity par plus 150% of any fund gain, up to a cap of 14%.

Investors would receive par if the fund fell by up to 22% and would lose 1% for each 1% decline beyond 22%.

“The buffer offers a good protection for a two year. From a point-to-point basis, it’s certainly very reasonable,” said Medeiros.

However the maximum return was too low, in his view.

The maximum return over two years is the equivalent of a 6.77% cap on an annualized compounded basis.

It only takes a 4.55% annual growth in the fund for investors to maximize their return.

“The cap over a 24-month period on a relatively risky asset class is a concern for me,” he said.

New cap

Doucette said he preferred the second product due to the buffer.

“You’re looking at a range bound market. You don’t see it going up much and you can see it going down. If you’re willing to get 7% you put some decent buffer on it,” he said.

But Doucette was also bullish on the EAFE.

“The outperforming asset class right now is U.S. large (cap),” he said.

“If you pull a little contrarian play on it, the EAFE is probably more fairly valued.

“I would change the structure a bit. I might lower the leverage and increase the cap. The market might run up a little bit. Why not take advantage of it?”

Doucette said he might have limited options on the leverage variable if he wanted to lower the cap.

“Perhaps if you get 1.1 or 1.3 times you could get to a 10% annual cap. I don’t know. I would have to see.”

Equity substitute

Overall, Doucette said he preferred this product. The large buffer with leverage despite a low cap was more attractive in his view than the absolute return payout.

“You know you have this buffer. It’s a guaranteed protection. On the upside, I’m not just long the index. I can get some leverage. I like it better. It all depends on the type of cap and leverage you can get,” he said.

Doucette said he uses those traditional leveraged buffered notes as an equity substitute for the appropriate asset class. In this case it would be for the developed markets equity bucket.

“You’d just replace part of the exposure you already have because you already made an allocation decision on the asset class. It’s just a matter of reallocating this exposure to these notes,” he said.

“It’s an interesting product. I like the buffer. But again, I would give up some leverage and increase the cap.”

The Cusip for the contingent risk absolute return notes is 06367TMC1.

The Cusip for the buffered bullish enhanced return notes is 06367TMA5.

Both issues will price on Oct. 26 and settle on Oct. 31.

BMO Capital Markets Corp. is the agent.

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