BNP’s buffered dual directional notes tied to Russell, Nasdaq offer compelling downside payout

By Emma Trincal

New York, Aug. 16 – BNP Paribas’s 0% dual directional notes due June 2, 2025 linked to the worst of the Russell 2000 index and the Nasdaq-100 index have little to offer on the upside, but the combination of a downside buffer with absolute return is attractive to some.

If each index finishes at or above its initial level, the payout at maturity will be par plus the return of the worst-performing index, capped at par plus 30%, according to a term sheet.

If each index finishes at or above the 85% buffer level, the payout will be par plus the absolute value of the return of the worst-performing index.

Otherwise, investors will lose 1% for each 1% decline of the worst-performing index beyond the 15% buffer.

Russell vs. Nasdaq

Carl Kunhardt, wealth adviser at Quest Capital Management, said the protection and downside payout were the most compelling aspect of the deal.

“I was going to like it with a 75% barrier. And it’s not a barrier but a buffer? I like it even more,” he said.

Both the Nasdaq-100 and the Russell 2000 are part of any equity allocation, he said.

When asked which of the two underliers may end up being the worst-of, he leaned toward the Russell 2000 index in a downside scenario.

“The Nasdaq being one of the large-cap indices may not be as volatile as the Russell,” he said.

“I see small caps either up more or down more. That means your exposure is to the Nasdaq if the market is up and to the Russell if it’s down. That would be my guess.”

Valuations, correlation

Kunhardt addressed the issue of current market valuations.

“We got out of small-cap last year due to the volatility. We progressively rebuilt our allocation back going to the third quarter,” he said.

“As a tech index, the Nasdaq has bigger swings sometimes.

“On the other hand, the Nasdaq has been overvalued for a decade and a half. Do I think it’s overvalued? Yes. Do I think it’s going to crash anytime soon? No. Do I think it should? Yes. But it hasn’t.”

The relatively high correlation between the two underlying indexes helped ease up the risk, he noted.

The three-year coefficient of correlation between the Nasdaq 100 index and the Russell 2000 index is 0.79.

A perfect correlation would be a coefficient of 1.

“Neither should be moving far from each other. Their moves up and down should be correlated,” he said.

Downside

While the payout on the upside lacked any return enhancement mechanism, Kunhardt said he was comfortable with the maximum return.

“I don’t mind one-to-one at 30%. This cap is pretty generous. Anyone who complains about a 30% cap for that term is quite greedy,” he said.

But what made the structure appealing was the downside payout.

“The driver of this note is the downside protection,” he said.

“I absolutely love the fact that it’s a buffer, and at 15%, it’s a substantial buffer.

“The absolute return is a great way to outperform the market.

The absolute return feature also made the worst-of exposure advantageous for once.

“You hope to see the worst-of go down as much as possible without breaching the trigger,” he said.

Creditworthiness

The issuer is not a broadly known name among U.S. retail investors. But the bank is financially healthy, he said.

“It wouldn’t be my first choice if I had to pick a non-U.S. issuer. Names like HSBC and Barclays are better known names. But BNP’s credit is quite good. Even though an issuer’s creditworthiness is rarely a big issue nowadays, it’s still always good to have,” he said.

To be sure, the five-year credit default swap spreads of BNP Paribas are much tighter than the tightest spreads seen in the United States.

BNP’s CDS spreads are 31 basis points versus 45 bps for JPMorgan and Wells Fargo, according to Markit.

No enhancement

Jerry Verseput, president of Veripax Wealth Management, was not interested in the notes mainly because of the limited gains on the upside.

“The terms just aren’t good enough. I’d rather wait a little bit in cash to get a little spike in volatility,” he said.

“The S&P is in a steady line. It slowly creeps higher, but there is no big move. At some point, we’re going to get a normal pullback and more volatility.”

More volatility would allow the issuer to increase the cap among other possible enhancements.

“I don’t particularly like the one-to-one on the upside,” he said.

“I’d rather have a digital or a coupon. If I’m getting the price return of a worst-of, I’d rather have some leverage.

“Anytime I’m not getting an interest rate or a digital return I always want a buffer. I have one here, but I want enough leverage so that that losing the dividend doesn’t hurt me. This note doesn’t do that.

“You’re guaranteed to underperform one of those indices, which is not something that entices me to give up my cash right now.”

BNP Paribas is the agent.

The notes will price on Aug. 26 and settle on Aug. 31.

The Cusip number is 05601JH94.

© 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.