BofA's notes linked to Merrill Lynch agriculture index offer high roll yield, bet on grains

By Emma Trincal

New York, March 18 - Bank of America Corp.'s upcoming notes linked to the Merrill Lynch Commodity index eXtra Agriculture index - Excess Return may appeal to commodity investors bullish on agriculture who seek an underlying index designed to add more yield by smoothing out commodity futures price fluctuations, sources said.

Bank of America plans to price three-year 0% Accelerated Return Notes linked to the index, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par of $10 plus triple any index gain, subject to a maximum return of 56% to 60% that will be set at pricing. Investors will be exposed to any index decline.

The Merrill Lynch Commodity index eXtra Agriculture, launched in June 2006, is a subindex of the Merrill Lynch Commodity index eXtra.

This subindex provides long exposure to futures contracts linked to a small number of agricultural commodities. Contracts are rolled over from the second month into the third month over a 15-business-day period prior to the month in which a contract expires, according to a Merrill Lynch global commodity research piece.

Rolling, rolling

Francisco Blanch, head of global commodities research and commodity strategist with Merrill Lynch in London and whose team created the index, told Prospect News that "the index provides a better roll mechanism" and that "it is designed to mitigate the impact of contango."

Commodity indexes are composed of commodity futures contracts that have a set expiration and delivery dates. Rolling is the process by which futures contracts as they approach expiration are replaced by contracts with a later expiration, Blanch explained.

A market is in "contango" when the prices are higher in the distant delivery months than in the nearer delivery months, which implies that contracts are bought at a higher price than they are sold.

Contango creates what experts call a negative "roll yield," which erodes the performance of the index.

Semi-continuously

Blanch, who declined to comment on the structured notes, said that the Merrill Lynch Commodity index eXtra Agriculture was designed to create the "optimal rolling mechanism."

"This index is different in two ways. First, it rolls over a two-week period rather than a five-day window, so you get an index that rolls semi-continuously," said Blanch. "I don't think there is anyone else having a longer rolling period than we do. This helps smooth out fluctuations in price."

As a second main characteristic, the index rolls futures contracts farther out in order to increase roll yields, he said.

Farther into the curve

"Rather than rolling from the front month to the second month, we do it from the second to the third month, for instance. It matters because in the normal cycle, everybody is selling the front month and buying the second month. What we do is buy the third month instead and sell the second. When everybody is buying, we're selling," said Blanch.

Higher yield

"This strategy enhances yields. It has been outperforming the other commodity indexes in the past," he said.

While he acknowledged that "others have imitated our index" and that "some have launched indexes that roll further back in the curve," Blanch said that the strategy was still preferable to the old model.

The gains of the strategy developed by Blanch and his team over indexes that use the five-day window and the front-to-second-month rolling schedule is about 3.4% per year, according to the research report.

Agriculture bulls

Investors may also find the notes attractive because they offer exposure to agriculture, a sector that may offer diversification away from precious metals, sources said.

Blanch said that he is bullish on agriculture for the next three to five years.

"Agriculture is a structural story with an unbalance between supply and demand. You see a lack of land or difficulties in expanding acreage. A lot of investors are recognizing the gap between supply and demand. They're adding to agriculture, and that will contribute to push prices higher," Blanch said.

Corn and growth

Some like the current composition of the index, which as of Tuesday allocated 75% to grains and seeds, 11% to sugar and coffee and 14% to livestock.

"I like the fact that this index has 75% in corn, soy and wheat. Corn is my biggest position in any commodity," said Matthew Bradbard, commodity trader and president of MB Wealth Corp. in Fort Lauderdale, Fla.

Bradbard said that he is very bullish on corn due to climate and demographical trends that impact supply and demand.

"There are so many weather problems, with cold winters, hurricanes, floods across the entire globe. All crops grow out of the ground, and there's a weather scare," said Bradbard.

"But it's also the growing population. China and India have a growing middle class. That represents more demand for protein and soy. And with China consuming more and more corn, they are going to have to import corn from the U.S., and it's going to happen over the next couple of years," he said.

Bradbard, who invests in commodities through options and futures only, said that the notes offer some appeal.

"I am a trader and I always prefer to invest in commodities directly and selectively," he said. "However, I like the fact that you get 75% exposure to [grains and seeds]. For an investor who is not a commodity expert and who is willing to invest for two or three years, that may not be bad," he said.

The notes are expected to price in March and settle in April.

Merrill Lynch, Pierce, Fenner & Smith Inc. and First Republic Securities Co., LLC are the underwriters.

© 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.