Morgan Stanley to price deals linked to diversified equity baskets on behalf of RBC, Citi

By Emma Trincal

New York, June 29 – Royal Bank of Canada and Citigroup Global Markets Holdings Inc. are each planning to issue leveraged capped notes linked to a diversified basket of equity indexes and exchange-traded funds, according to two separate filings with the Securities and Exchange Commission.

Morgan Stanley Wealth Management is the dealer on both upcoming offerings.

The two products share some characteristics such as short tenor, sizable leverage, mid-double-digit caps and no downside protection feature.

The underlying baskets give investors access to broad U.S. and international equity benchmarks. The mix also includes exposure to a limited number of U.S. sectors.

The first deal to come is RBC’s. It is the shorter of the two with a six-month tenor.

RBC plans to price 0% Performance Leveraged Upside Securities due Dec. 23, 2016 linked to a basket composed of the S&P 500 index with a 25% weight, the Euro Stoxx 50 index with a 25% weight, the Market Vectors Gold Miners ETF with a 15% weight, the SPDR S&P Bank exchange-traded fund with a 15% weight, the WisdomTree Japan Hedged Equity Fund with a 10% weight and the WisdomTree India Earnings Fund with a 10% weight.

If the final basket level is greater than the initial basket level, the payout at maturity will be par of $10 plus 200% of the basket return, subject to a maximum return of 8.08%. If the final index level is less than the initial index, investors will be fully exposed to the decline.

The fee for this deal is 1.75%.

Short, not cheap

“This is strange,” a market participant said.

“Such a short-term deal ... If it wasn’t for the fee I would have immediately thought it was an institutional investor. Retail doesn’t do less than one year. They don’t want to be taxed on short-term capital gains,” he said.

Institutional investors tend to invest in shorter maturities because the tax liability is not such a concern, especially for pensions, he explained.

But the 1.75% fee is more expensive than what institutions would pay and is more consistent with a retail investor’s profile, he added.

“Institutions buy short-term products but for a fraction of that cost. It’s definitely a retail fee, but it’s so strange for a small investor to buy a six-month,” he said.

“Why would you be seeking to pay a lot more taxes, double-tax if you win? It’s unusual for investors to be so clear about their view that they’re willing to pay more tax on it.

“Maybe it was done for a retirement account. That’s the only way it would make sense to me.”

Citi

Citigroup plans on pricing the second deal. The 13-month tenor is longer. The leverage factor is three instead of two.

The 0% Performance Leveraged Upside Securities due Aug. 4, 2017 are linked to similar basket.

For instance, the basket for the Citi notes also includes the S&P 500 but with a 40% weight.

The Euro Stoxx 50 index remains part of the allocation with a 12% weight as well as the WisdomTree Japan Hedged Equity Fund with a 12% weight.

The different components are the Technology Select Sector SPDR Fund, the Energy Select Sector SPDR Fund and the iShares Russell 2000 exchange-traded fund, each with a 12% weight.

The cap is 14.85%. The fee is 2.25%.

“This second one is easier to understand,” the market participant said.

“It’s 13 months, so a retail investor gets the most favorable tax treatment. And the fee is more in line with what retail investors tend to pay.”

The highly levered structure with a cap and no downside protection is less common than leveraged capped notes featuring either a buffer or barrier, he noted.

“You’re not getting capped in exchange for protection. I guess what you’re getting is a short maturity and more leverage,” he said.

Pricing

The diversification did not add any pricing advantage, he noted.

“Both notes are capped, so you’re selling volatility. The more volatility, the better the terms and since a basket usually lowers volatility, it was probably not factored into pricing,” he said.

Instead issuers must have taken advantage of the increased volatility seen in the overall market.

“The market is volatile enough to deliver [an] attractive premium when selling the cap,” he said.

The rationale in both deals is investors’ desire to diversify a portion of their equity portfolio in one security, he said.

“These types of deals are access deals. People just want to go long equities, and they need to diversify their portfolios,” he said.

Diversified portfolios

Diversification across several geographic markets and equity sectors is the main objective behind both deals, said an industry source.

“It’s all equity, but you’ve got a bunch of different things in there,” he said.

“With rates looking more and more on hold, people want to buy equity.

“In the Brexit context I can see people trying to buy on the dips, short-term.

“Having a diversified global portfolio has become very important for U.S. investors. More and more people are looking outside of the U.S. In general it’s always a good thing to diversify a portfolio.”

RBC Capital Markets LLC is the agent for the RBC notes with Morgan Stanley Wealth Management acting as distributor. The notes (Cusip: 78014C343) were scheduled to price Thursday.

Citigroup Global Markets Inc. is the agent for the Citi notes. Morgan Stanley Wealth Management is a dealer. The (Cusip: 17324P388) notes will price July 1.

© 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.