Bank of Montreal’s notes linked to Raymond James basket of stocks offer bet on oil turnaround

By Emma Trincal

San Luis Obispo, Calif., Jan. 13 – For investors who expect oil prices to recover, Bank of Montreal’s 0% equity-linked “oil market recovery” notes due July 29, 2016 offer an opportunity to get exposure to a basket of stocks selected by Raymond James & Associates in the energy sector.

The underlying stocks, which are equally weighted, are Basic Energy Services, Inc., Bonanza Creek Energy, Inc., Chevron Corp., Concho Resources Inc., Energy Transfer Equity, LP, Chart Industries, Inc., Nabors Industries Ltd., Oasis Petroleum Inc., Occidental Petroleum Corp., Plains GP Holdings, LP, Phillips 66, Patterson-UTI Energy, Inc., RSP Permian, Inc., Targa Resources Corp., Valero Energy Corp. and Whiting Petroleum Corp.

The issue price will be $1,027.50 per $1,000 principal amount of notes, according to a 424B2 filing with the Securities and Exchange Commission.

Raymond James’ following

“The premium is pretty high, and you also have the redemption fee, although it’s much less. Overall it’s over 3%. I imagine that while it’s pricey, some people will find the product interesting,” said Tom Balcom, founder of 1650 Wealth Management.

The payout at maturity will be par plus the basket level percentage minus the redemption adjustment amount of $3.50, according to the prospectus.

When adding the premium and the redemption fee, the basket return needs to exceed 3.1% in order for investors to receive a redemption amount that exceeds the issue price.

“If you trust Raymond James research, if you’re bullish on oil, you pay a premium for them to package their best picks in this sector for you,” he said.

“The question that comes to mind is, why not buying the 16 stocks directly? This product is probably interesting for these folks who like Raymond James’ best ideas. The notes ease up transactions, ease up the exposure. It’s their best pick in just one Cusip. There is no need to pick the names or to monitor the portfolio. If a recovery in oil does occur, then hopefully, you’re able to do well.”

For smaller accounts

Juin Chin, senior investment analyst at Modera Wealth Management, LLC, said that the product, apparently not cheap, may actually be cost-efficient for the small investor.

“You can always buy the 16 stocks individually,” he said, referring to the names all listed in the prospectus.

“The structured note has a pretty high hurdle, the 3.1% breakeven they mention.

“Let’s see if it makes sense to buy the stocks directly or the notes.”

He ran the following breakeven analysis based on an $8 commission fee for the purchase of a stock. For the “round trip,” or the buy and sell, the commission would be double, or $16. He multiplied that amount by the 16 trades to obtain a total commission cost of $256 for the portfolio that would be incurred by investors seeking to buy the equity and replicate the basket directly.

He then divided the commission cost by the hurdle – or $256 by 3.1% – to determine a breakeven size for an account at $8,258.

“Above $8,258 you’re better off buying the shares yourself. But if you are a small investor, if you don’t have the $8,000 to invest, then it makes sense to buy the notes. It’s more cost-efficient,” he said.

There was no benefit in being a shareholder over being a noteholder in terms of dividends, he said, as the notes give investors exposure to the total return of the basket.

“In that sense, you’re not losing on the dividends as it often is the case with structured notes,” he said.

On the other hand, investors buying the basket directly benefited from two advantages.

First, shareholders would not have counterparty risk exposure.

Second, the equity investor would have full liquidity to sell all or some of the basket components at any time, he said.

“Other than that, I guess the decision to buy the stocks or the notes boils down to the size of the account,” he said.

A hard call

Chin was skeptical about the notes’ underlying macroeconomic theme.

“Timing matters. Is now a good time to take a contrarian bet on oil?” he said.

“Investors in the notes may believe they are buying a basket of stocks. But ultimately, it’s a bullish bet on oil. These companies are engaged in drilling, exploration, oil production. The performance of these stocks is very correlated to oil prices. It’s really a call on where oil is headed because no matter how great the 16 stocks are, if oil is in a long-term bearish trend, your basket is not going to do well.”

Crude oil prices closed at around $46 a barrel on Tuesday. Prices have dropped by more than 50% since their peak last summer.

“Oil is taking a big hit right now. How many strategists just a few months ago predicted that oil would go down from $100 to $40? We know very few people that made that call. In fact, almost no one got this right,” he said.

The excess supply seen in oil could cause prices to stay low for a while.

“In the 1980s the oil glut kept prices depressed for 20 years,” he said.

“This note is not just about stock-picking. It reflects your outlook on oil supply.

“If you think it’s a technical imbalance and that it will reverse, the product could make sense. But if oil prices stay down, it might not be such a great idea.”

BMO Capital Markets Corp. is the agent. Raymond James is the distributor and will receive $27.50 per note for its services.

The notes (Cusip: 06366RZF5) are expected to settle Jan. 30.

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