Citigroup’s contingent coupon autocall on China-focused ETF offers bold bet amid bear market

By Emma Trincal

New York, July 9 – Citigroup Inc.’s autocallable contingent coupon equity-linked securities due July 31, 2020 linked to the Deutsche X-trackers Harvest CSI 300 China A-Shares exchange-traded fund may appeal to investors who believe that money can be made when there is “blood in the streets” as the Chinese stock market is well into bear market territory, sources said.

The fund offers exposure to stocks in Mainland China. It tracks the CSI 300 index, which consists of the 300 largest and most liquid stocks in the China A-share market.

The notes will pay a contingent quarterly coupon at an annual rate of 8% to 10% if the fund closes at or above the coupon barrier level, 70% of the initial price, on the valuation date for that interest period, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if the fund closes at or above the initial level on any quarterly valuation date beginning July 28, 2016.

If the notes are not called and the final share price closes at or above the 70% barrier level, the payout at maturity will be par plus the last coupon.

Otherwise, investors will be fully exposed to any losses.

Bubble burst

The fund over the past year skyrocketed up nearly 80% and is still up 9.35% for the year.

But over the past month, the Shanghai stock exchange crashed.

Mainland Chinese stocks are driven by individuals, while Hong Kong stocks are traded primarily by global institutional investors, according to Schwab stock analyst Michelle Gibley.

Since its high at the end of May, the ETF declined by 38% through Wednesday when share prices tumbled. On Thursday, the fund bounced significantly rising 20% for the day as the government pursued its efforts to reverse the plunging share prices.

“It would have been even more interesting if they had picked Wednesday for the strike,” said Steve Doucette, financial adviser at Proctor Financial.

“Obviously it’s a pretty volatile market.”

Recent prices are short-term market moves, however, which will mean nothing five years from now, he noted.

“We had a serious pullback over the past few weeks. Today everybody is buying shares without knowing what they’re getting into.

“The question is what’s going to happen in China between now and 2020, and that’s the tough one. It goes back to doing your due diligence.

“I like the terms of the notes. If you get called you get your coupon too. It’s a very generous contingent coupon. You can use this note either as an income or equity substitute.”

Other risks

Making an investment decision to invest in China requires balancing the political risks with the potential reward of economic growth.

“China is still the second largest economy in the world, growing faster than anybody else,” he said.

“The question is whether the government’s policies will hurt the potential of this economy and its capitalistic forces. It’s still a communist country. You have to decide if you’re comfortable with the role of the government in the economy.”

The combination of several risks – a volatile market, government regulations – give investors “favorable terms,” he said.

“We would have to look at this underlying more closely because we typically limit our investments to broad indexes. We tend to avoid single-country funds. But if this index is a broad-enough benchmark that can capture the entire Chinese economy we would be certainly interested in looking at it closer simply because the risk-reward is very attractive.”

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said that recent government actions, while reassuring for the market short-term may be a liability in the long run.

In order to stem the sell-off, the Chinese authorities have implemented new measures such as trading halts, a crackdown on margin, suspension of IPOs and harsher reserve requirements for banks for instance.

Unintended consequences

“China is very interesting for us to look at. The challenge with this market though is that it has been artificially supported, which makes it harder to value or monitor,” Medeiros said.

“The Chinese market had a fantastic run up until June of this year and since then has been going through a major sell-off. The Chinese government is trying to manipulate this sell-off. China remains an opportunity. However, those governmental interventions pose additional risks, political risks in particular.

“The creation of this bubble has been the unintentional consequences of the Chinese government’s efforts to support the market.

“When you have a government that steps in to manage the sell-off, assets have to be repriced. It has an impact on someone’s perception of the value of those assets.”

Autocall

The structure of the product has some drawbacks, he added.

“What’s challenging with autocallable notes, especially when using them with a very volatile underlier like in this case, is to predict future income. Investors are facing several risks. The coupon is contingent and they don’t know if they’re going get paid or when. In addition to that, if there is a call, they are subject to reinvestment risk.”

Citigroup Global Markets Inc. is the underwriter.

The notes will price July 28.

The Cusip number is 17298CCV8.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.