Bank of the West’s CDs linked to DWA Large Cap Sector Rotation provide access to top sectors

By Emma Trincal

New York, June 23 – Bank of the West will price Wednesday its second certificate of deposit linked to a smart index created by technical analysis guru Tom Dorsey in one of BNP Paribas’ latest efforts to provide investors with access to equity research, sources said.

Bank of the West, the issuing arm of BNP, plans to price 0% market-linked CDs due June 30, 2021 linked to the DWA Large Cap Sector Rotation Target Volatility 7 index, according to a term sheet.

The payout at maturity will be par plus 115% to 120% of the index return, subject to a minimum payout of par. The exact participation rate will be set at pricing.

The reference index is published by Dorsey Wright & Associates. The registered investment advisory firm was co-founded by Dorsey, who “has an extremely strong following” among financial advisers, according to an industry source.

Content first

“This new offering is in line with what BNP has done in the past: bringing more story, more research in structured products. Investors are looking for new things – a little less about payout and structure and a little bit more about content,” the source said.

The underlying index invests in the DWA Large Cap Sector Rotation Total Return index, which provides exposure to the five top-ranked U.S. equity sectors based on DWA’s proprietary research, according to the term sheet.

The strategy seeks to capitalize on the historical tendency of sectors to diverge from one another through the course of major U.S. equity market cycles, the term sheet said.

The index rotates the sectors based on positive sector performance trends identified by the research firm.

Fifty sector and subsector exchange-traded funds are compared monthly, and the index systematically invests within the top five ranked sectors each month, on an equal-weighted basis, using State Street’s Sector SPDR ETFs.

“The best way for us to offer content is to use the smartest minds and partner with them in order to give investors access to their research through structured products,” Raul Perez, head of structured solutions at BNP Paribas, told Prospect News.

The first DWA Large Cap index-based CD priced in May for $19.62 million, according to a term sheet.

Through its Bank of the West CD platform, BNP has priced other so-called “access” or “content” deals linked to a research-oriented index, the Morningstar Ultimate Stock-Pickers Target Volatility 7 index. The index replicates a stock-picking list established by Morningstar with a volatility target of 7%, as stated in its name.

Volatility under check

The DWA Large Cap Sector Rotation Target Volatility 7 index offers the same volatility target, with volatility monitored daily. The index will increase sector exposure during periods of low volatility and decrease exposure as volatility expands, according to the term sheet. Through this process, the volatility controls can allow the index to become fully invested, or hedged in periods of high market volatility, in the sector rotation strategy.

Controlling the volatility of an underlying index is one of the ways issuers have been using to overcome some of the pricing limitations they face, especially when the structure, as this one, combines uncapped leverage on the upside and full principal protection, said Perez.

“Setting the volatility is key to price those notes,” he said.

“It cheapens the cost of the calls. You could never buy 1.2 calls with full principal protection based on an equity index like this one, by nature extremely volatile.

“If you didn’t have the target, the type of participation you would get would be below 100%. Just as an example, a seven-year principal-protected note tied to the S&P would probably give you around 45% participation on the upside.

“For this one, it would be even worse. The option is so expensive because the volatility on this index is averaging 17%. It becomes unpriceable to get 100% upside participation, uncapped if there is no target volatility. You just can’t do it.”

The use of indexes with volatility targets to circumvent those difficulties is not entirely new, he said, pointing to JPMorgan’s Efficiente 5, “one of JPMorgan’s most popular systematic strategies,” he said.

JPMorgan Chase & Co. has been pricing both CDs and notes linked to the JPMorgan ETF Efficiente 5 index. Those securities are fully protected on the downside and offer uncapped leverage on the upside.

The Efficiente index provides exposure to a range of asset classes and geographic regions based on the modern portfolio theory approach to asset allocation.

Another example comes from JPMorgan Chase Bank, NA, which recently said in a term sheet that it will price variable annual income CDs due June 30, 2021 linked to the JPMorgan High Yield ETF Volatility Target index 3%.

“We’ll see more and more underlying indexes using controlled volatility. It’s been done before, but the trend is getting more and more visible. Issuers don’t have that many options. They can lower the participation rate or cheapen the options by introducing indexes that keep volatility under control,” he said.

Joint effort

“We partner with a certain number of parties: Dorsey Wright for the research, Bank of the West for the issuance of our CDs and Elkorn for the education and distribution of the CDs to financial advisers,” Perez said.

Elkhorn and Dorsey Wright have created a strategic research partnership to design “structurally diverse investment solutions for advisers,” according to Elkorn Investments’ website.

“So far, DWA research was available through separately managed accounts, ETFs and UITs,” said Ben Fulton, chief executive of Elkhorn Investments.

“Now they’re entering into the CD space for the first time.”

Perez said that BNP will try to market the new CD once a month.

The bank already has about a dozen broker-dealers working on the new CD deal, and it expects twice more by the end of the month, the industry source said.

“We had some success with the Morningstar CDs. This is a good complement for people who don’t want to follow a stock but instead would rather focus on sectors. It gives them a broader approach. It’s a retail product for the more conservative investors who want to have an asset allocation approach to their portfolio,” Perez said.

“Down the road, we’re considering using the same Dorsey Wright index but for a structured note. That one would be aimed at high net worth clients.”

BNP Paribas Securities Corp. is the agent. The fees are expected to be up to 4%.

The CDs will price Wednesday and settle Monday.

The Cusip number is 06426XKX7.

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