Advisors want some protection with BofA’s market-linked step-up autocalls tied to Russell

By Emma Trincal

New York, July 13 – BofA Finance LLC’s 0% autocallable market-linked step-up notes due July 2020 linked to the Russell 2000 index enable investors to get a decent call premium or digital return with the additional option of full upside participation. The absence of a cap is an advantage, advisers said. But having no barrier or buffer represented a serious stumbling block in a market most would consider toppish.

The Russell 2000 index closed on Thursday at 1,426, only 8 points lower than its 52-week high.

The notes will be at par plus an annual call premium of 8.5% to 9.5% if the index closes at or above its initial level on either annual call date, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes at or above the step-up value – 130% of the initial level – the payout at maturity will be par of $10 plus the index gain.

If the index is unchanged or gains by up to the step-up level, the payout will be par plus the step-up payment of 30%.

Investors will lose 1% for each 1% index decline.

Narrow bet

Steve Doucette, financial adviser at Proctor Financial, said that the notes are a match for investors with a very specific kind of view. But it may be a narrow view or one that does not take into account current market valuations with the risk of a downturn.

“You don’t expect the market to do much but you expect it to be positive. It has to be positive since this thing has zero protection,” he said.

Call is best

The best scenario is the automatic call event, he said.

“If you stay in until maturity, theoretically you can collect nothing and lose money too,” he added.

“You’re looking at 9% after one year and you get your money back. That’s the best scenario.”

He assumed a call premium of 9%, which is the mid-point of the range stated in the prospectus.

If the index ends up trading sideways or up but by less than the step value, “it kind of plays out,” he said.

Secondary market

But any market decline would penalize investors with the full downside exposure. This was his greatest concern.

“If you don’t get called year one and year two, you get a note that’s under water. You can’t sell it out,” he said.

Doucette invests in structured notes assuming that he may want to redeem the notes early. His decision to buy a note is therefore based on secondary market pricing expectations. An early exit if the notes were not called would probably mean that the index performance was and would continue to be negative, he said.

Downside risk

“You really have to be bullish to mildly bullish because you’re locking up your money for three years, with no downside protection hoping that the market will stay in the range of 10% a year or less since that’s the only way you can outperform.

“Ten percent is good, don’t get me wrong. But above that you don’t outperform,” he said. “And below zero, you’re long the index with a loss.

“Are you willing to take the full downside risk? That’s the thing.

“I can’t get out if the market turns.

“It’s hard to be excited about this.”

Risky

Brian Rettig, portfolio manager at the Institute for Wealth Management, said he would not consider the notes for the same reason.

“I don’t like giving up downside protection,” he said.

“The Russell has been kind of flat after a big move since the elections.”

The small-cap benchmark jumped 20% between the November presidential elections and early December.

“I wouldn’t mind getting 9% after one year if it’s flat or 18% after two. But I would prefer to see some sort of downside protection at these levels. We like to buy these notes with a little bit of downside.”

Rettig conceded that not being capped at the step level may be advantageous for some investors. But getting the one-to-one upside participation above 130% would not justify investing in the notes for three years.

An index fund investor getting the total return of the benchmark would outperform the notes in this case.

Tradeoff

“It’s a tough one. I think it would make sense to go a little longer and get a buffer,” he said, arguing that another year would probably be sufficient to achieve this result.

“You would probably have to have a cap. But I don’t mind having a cap right now,” he said pointing to a U.S. stock market which keeps on setting new highs.

“Valuations are going to put a ceiling on how far the index is going to go anyway. Given the market we’re in I wouldn’t mind a cap in exchange for a little downside protection.”

Another deal

BofA Finance is prepping another offering of autocallable market-linked step-up notes due July 2019 linked to the PHLX Housing Sector index.

The structure is the same with the following exceptions: the two-year term is shorter; there is only one automatic call date; the call premium is set at 8.5%; and the step-up value is comprised between 112% and 118%.

For both upcoming offerings Bank of America Corp. will be the guarantor and BofA Merrill Lynch the agent.

The notes will price in July and settle in August.

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