RBC’s barrier booster notes on S&P 500, Stoxx designed for long-term, moderately bullish play

By Emma Trincal

New York, Nov. 29 – Royal Bank of Canada’s 0% barrier booster notes due Nov. 29, 2027 linked to the worst performing of the S&P 500 index and the Euro Stoxx 50 index are aimed at long-term investors seeking to outperform the markets in a moderate-return environment.

If the return of the lesser performing index is flat or positive, the payout at maturity will par plus the greater of the return of the lesser performing index and the booster coupon, according to an FWP filing with the Securities and Exchange Commission.

The exact value of the 50% to 60% booster coupon will be set at pricing.

If the lesser performing index finishes flat or falls by up to 40%, the payout will be par.

If the lesser performing index falls by more than 40%, investors will lose 1% for every 1% decline of the lesser performing index below the initial level.

Beating the market

Steve Doucette, financial adviser at Proctor Financial, said the booster was attractive in today’s toppish market.

“I kind of like this note for a long-term play. Unless the market is down in six years, you’re guaranteed a 10% return,” he said.

“That’s pretty good after more than 12 years in this bull market. I don’t think you can reasonably expect a lot more in the upcoming years.”

Modest returns ahead

The minimum payment reduces the negative impact of the worst-of in a low-return environment, he said.

“You don’t know which of the two indices is going to underperform. But if returns are small, you may beat both of them pretty easily,” he said.

The only piece of the deal Doucette may consider modifying would be the downside.

“I don’t think we’re going to see a 40% drawdown six years from now.

“I would probably try to reduce the size of the barrier so I can replace it with a buffer,” he said.

Tradeoff

For Jonathan Tiemann, president of Tiemann Investment Advisors, the tenor was problematic.

“A 60% barrier is a meaningful protection. I guess it’s probably cheap to price it on a six-year because you may not need that much protection after all,” he said.

A more obvious drawback associated with the long timeframe was the “loss” of dividends, which, compounded over six years, would impede the performance of the notes, he said.

“You could be looking at a 7% to 8% opportunity cost over the six-year term,” he said.

The worst-of exposure added another layer of risk.

“These two indices are more correlated than they seem. But still, it’s the U.S. versus Europe,” he said.

The five-year coefficient of correlation between the two underlying indexes is 0.78.

“Basically, you pay for the booster and the downside protection with the worst-of and the dividends,” he said.

“In the meantime, you get nothing.”

Limited liquidity

One of Tiemann’s main objections to structured notes in general is the limited activity in the secondary market.

“It’s conceivable that there may be some liquidity. You may be able to redeem the notes early. But you shouldn’t count on it,” he said.

Issuers in their prospectuses recommend that investors hold their structured notes until maturity and, in this case, for six years.

“It’s a long time,” he said.

“A 55% gain over a six-year timeframe is not terrible. But it’s not a very exciting either.

“If you want to play income, you should look for an autocallable-type of investment.

“If you are bullish, you don’t want to give up the dividends for six years.

“I’m not sure what kind of investor would be looking at this note,” he said.

RBC Capital Markets, LLC is the agent.

The notes were expected to price on Nov. 23 and to settle on Nov. 29.

The Cusip number is 78016F5Q3.

© 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.