New York, Oct. 4 - BNP Paribas' upcoming 0% return enhanced notes due Oct. 30, 2015 linked to a basket of common stocks selected from the Richard Bernstein Advisors American Industrial Renaissance universe is one of the latest examples of the growing use by issuers of intellectual property and stock-picking processes in an effort to build notes with better growth potential.
The American Industrial Renaissance investment theme was developed by Richard Bernstein, chief executive officer of Richard Bernstein Advisors LLC and former chief investment strategist at Merrill Lynch & Co.
The strategy focuses on small and mid-cap U.S. companies in the industrial and community banking sectors on the view that the sector will gain market share and generate growth.
"We are always looking for opportunities where we believe the underlying may offer our client a more focused, theme-based exposure than the rest of the market and we think that Richard Bernstein's model is one of those opportunities," Serge Troyanovsky, managing director, head of retail distribution-structured equity at BNP Paribas, told Prospect News.
"The investment theme is based on the belief that the U.S. manufacturing sector is in the beginning of economic resurgence and as a result small and mid-cap domestically-focused manufacturing and industrial companies are beginning to gain market share."
Under the terms of the notes, if the final basket level is greater than or equal to the initial basket level, the payout at maturity will be par plus 150% of the basket return, subject to a maximum return of 30% to 35% that will be set at pricing, according to a term sheet.
If the final basket level is less than the initial basket level, investors will have one-to-one exposure to the decline.
The distinctive aspect of the product was less the structure itself than the way the underlying basket was created, he said.
"The stocks that we selected in the basket are based on an innovative research 'theme' which is just gaining acceptance, but still sufficiently new to hold a potential for growth," he said.
"This is the first note ever that is based on the Richard Bernstein Advisors American Industrial Renaissance proprietary research."
The structured products market has evolved in the United States as investors are pursuing themes or best ideas for their portfolio and not just the best terms, he said.
"We are seeing a trend towards some of those value-added offerings, especially notes tied to some research-based strategy," he said.
"We've seen the Bank of Montreal notes linked to a static basket selected by Raymond James. More recently, Scotiabank came up with a more than $100 million deal also tied to Raymond James research - this time though through an index based on current analysts' picks
"All these new underlying indexes or baskets based on research point to a maturing of the structured products industry.
"The space started out with products linked to some of these broad indexes. The value of the structured products brought to clients at the time came exclusively from the terms of the deal - downside protection, upside leverage, various forms of return enhancement, etc. The initial stage of our industry was payoff-driven. Now, we are more and more focusing on simpler payoffs but more value-added underliers.
"This is why more than a year ago we decided to tap into the research of Morningstar by using the Morningstar Ultimate Stock-Pickers index, which has been the basis for many of our CD offerings since then," Troyanovsky said.
| In August, BNP Paribas | announced that it had entered into a license agreement with | Richard Bernstein Advisors LLC | (RBA) to use Richard Bernstein's intellectual property.
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| "This is quite unique. Until the structured note comes up, the UIT is the only pure play on the space," Bernstein told Prospect News, referring to the Richard Bernstein Tactical Series, American Industrial Renaissance Portfolio.
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| "There are very few products in the market that actually capitalize on the American Industrial Renaissance theme.
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| "This is the first structured note that has licensed our research. We have entered an exclusive agreement with BNP."
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| Renaissance
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| The American Industrial Renaissance methodology focuses on the small-cap U.S. manufacturing sector.
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| "We believe that small and mid-cap U.S. companies in the industrial and manufacturing sector will gain market share over the coming decade, said Bernstein.
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| The strategist said that he is bearish on emerging markets and sees outsourcing as a declining trend in the U.S.
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| "Over the 1990s and 2000s outsourcing sounded sexy. It was executed to lower labor costs. But companies realize now that the labor cost differentials are much narrower between the U.S. and the rest of the world, in part due to the weakening of the unions here and also because emerging market countries have seen their own wage increase," he said.
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| U.S. manufacturing wage growth has not only lagged China but also the rest of the world, he noted.
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| "In addition to that, people have underestimated the costs associated with manufacturing offshore, in terms of quality control, for instance.
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| "This is why we've seen a large number of industrial firms bringing back their operations into the U.S., such as in the textile industry, in appliance manufacturing or with basic industrial parts.
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| "People when they think of outsourcing have been focusing on margins. But this is not a margin story. This is a market shares story. There are two ways to increase profitability: market shares and margins.
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| "We are bullish on the U.S. small cap industrial sector and bearish on emerging markets because we think that many investors underestimate the problems faced by those countries, such as China, India, Brazil, Egypt, Turkey, Indonesia.
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| "The majority of companies in emerging markets have had negative earnings for over a year.
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| "Our bottom-up analysis shows that U.S. small cap companies for the next 12 months are projected to grow double the growth of emerging markets," he said.
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| Troyanovsky said that the American Industrial Renaissance was a growth story that is appealing to bullish investors.
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| "We've discussed it with a number of clients already and we've received a very positive feedback. Most of our clients are institutional investors, including banks, broker-dealers and registered investment advisers who cater to retail. The American Industrial Renaissance is a theme that really resonates with many of them. They like the idea. They are themselves real believers in this idea. In fact, the support that we've received comes from the management of those institutions, the investment strategists for instance, rather than just the structured product desk," he said.
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| Screens and filters
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| The Richard Bernstein Advisors universe as of September 24, 2013 comprised 79 stocks. These stocks are selected by RBA from the Russell 2500 Index based on various quantitative factors, with the goal of identifying companies that may benefit from a potential recovery of the manufacturing sector in the U.S., according to the term sheet.
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| The Russell 2500 is comprised of the smallest securities in the Russell 3000. The Russell 3000 consists in the 3,000 largest U.S. companies determined by market cap.
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| "In their own methodology, they select about 80 stocks that best identify the theme of American Renaissance," said Troyanovsky.
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| "They start with the Russell 2500 as they don't want large caps. Then they only keep stocks in the manufacturing and community banking sector, with a weighting in industrials of about 90%.
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| "Second, they want U.S. companies that do most of their business in the U.S. So if the company has more than 25% of its business conducted offshore, they will not be included.
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| "Thirdly they eliminate small companies defined as companies with a share price of less than $6.
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| "A final growth filter is applied to the remaining stocks. They will pick only the companies with positive 12-month forward earnings estimates.
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| "That's the basic idea. The other portfolio criteria for the Richard Bernstein American Industrial Renaissance are proprietary quantitative filters.
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| "But this is their concept in a nutshell. And we find that the theme is well understood," he said.
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| Narrowing it down
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| The underlying basket in the notes however is the result of BNP's own selection process to constitute the basket of 10 stocks.
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| "We wanted to create a structured note on this theme but we couldn't really use all these stocks," he said.
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| "We have developed liquidity screens to select a basket on which we - BNP - are able to provide the options.
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| "From the initial stock universe of RBA American Industrial Renaissance, we use two filters: first the stocks must have an average daily volume of $5 million or more and two, the notional amount of the option contracts must be at least $200,000.
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| "That's how we translate the wider universe of Richard Bernstein's research into a basket of 10 stocks. This basket enables us to write a structured note," he said.
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| Troyanovsky said that only one financial stock was included in the underlying basket.
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| "Bernstein's research identifies stocks in the industrial and small bank sectors. But the introduction of financial stocks is only relevant when the midcap community bank or small bank will benefit from the American Industrial Renaissance to the extent that they lend to industrial companies and contribute to their capital growth," he said.
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| "There is only one financial stock in our basket, Huntington Bancshares Inc. In general, Richard Bernstein doesn't want financial stocks to represent more than 10% of his portfolio," he said.
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| The nine other stocks in the basket are: Acuity Brands, Inc., American Railcar Industries, Inc., Covanta Holding Corp., Generac Holdings Inc., MasTec, Inc., Proto Labs, Inc., Quanta Services, Inc., Trinity Industries, Inc. and URS Corp.
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| Next
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| "We do plan to follow up on this offering in the future months," said Troyanovsky.
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| "We are considering a number of variations on the payoff. Additionally, at some point, we will consider this type of product in a CD format.
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| "We wanted to start with a very simple, transparent payoff so we can focus on the theme first. As clients become more comfortable with the American Industrial Renaissance story, we will expand into different structures and wrappers, such as CDs," he said.
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| The notes are expected to price Oct. 28 and settle Oct. 31.
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| BNP Paribas Securities Corp. is the agent.
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| The Cusip number is 05574LQW1.
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