RBC’s $4.9 million autocalls on Nasdaq, Russell offer fair risk-reward for income play

By Emma Trincal

New York, Sept. 28 – Royal Bank of Canada’s $4.9 million of 0% autocallable geared buffered absolute return notes due March 24, 2025 linked to the worst performing of the Russell 2000 index and the Nasdaq-100 index offer enough benefits to justify taking the equity risk, advisers said, adding that the note is aimed at income-seekers with a sideways view on the market.

The notes will be called automatically at par plus 11.65% per year if each index closes at or above its initial level on any semiannual review date, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called at maturity and the worst-performing index falls by no more than 20%, investors will receive par plus the absolute value of its return.

Otherwise, investors will lose 1.25% for every 1% decline of the worst-performing index beyond 20%.

Note versus Treasuries

“In general, I don’t like worst-of deals only because things could turn out very badly with just a couple of negative events,” said Scott Cramer, president of Cramer & Rauchegger.

One of the two underliers may carry more risk.

“The Nasdaq is heavily weighted in a small number of growth stocks plus it only has 100 holdings versus 2,000 for the Russell.”

Cramer said that comparing the premium of the notes with Treasury rates is a clear way to assess the risk-adjusted return of the notes.

“If you take the Treasury yield as your benchmark at 5.5% and assume just to simplify the math that your premium is 11%, you’re getting two-times the return of the risk-free rate,” he said.

“For the risk of earning two times the guaranteed Treasury rate, is it worth taking the risk on the note?”

This aspect of the question only considered the call premium.

Negative is positive

“To be fair, you have this 20% geared buffer plus a potential gain on the downside with the absolute return.”

A 15% decline would give investors a 15% positive return, he said.

“It feels like it’s worth the risk. You have some good protection, and you can also make money on the downside,” he said.

Cramer was neutral on the timeframe. But the downside protection added significant value.

“Eighteen months from now, will we be down 20%? Clearly things can happen. It’s a good thing that you have a buffer, not a barrier. It’s even better that you have the buffer plus the absolute return. If it was just a buffer, I wouldn’t think the deal would be worth as much,” he said.

To conclude, Cramer said the payoff was “fair.”

“I think the risk-reward is there if you want the extra income.”

Alpha on the way down

Steve Doucette, financial adviser at Proctor Financial, said the notes fit a specific view.

“It’s for an investor who thinks the market is going to be range bound in the next 18 months. They don’t expect much upside,” he said.

The biggest advantage of the note was the downside payoff.

“You’re trying to catch some outperformance with the buffer and the absolute return,” he said.

Despite the gearing, investors were likely to outperform at all times on the downside.

“If the market is down, you’ll outperform. If it’s down less than 20%, you’ll outperform in a huge way.

“If it’s down more than 20%, you’ll still outperform,” he said.

The leverage on the buffer was not a big concern.

“In theory you could lose 100%. But it’s not really relevant because it takes a lot to chew up a 20% buffer on the negative side,” he said.

Some risks

The call premium was also attractive.

“Nobody is going to complain about getting almost 12%. The only regret you may have is if you’re called at maturity and the market is up more than 18%.”

He was referring to the maximum return at the end of the term, which would be 17.475%.

Doucette said he would need to assess the risks associated with the investment.

“From an asset allocation standpoint, you have to ask yourself: do I need to hedge and look for a little income or should I avoid taking the downside risk?

“It may not be a bad idea to get some income if you see the market trading sideways,” he said.

But the risks are real.

“It’s an 18-month note. We’re going through an Election year. Who is going to be the president next year? You can expect some volatility during that time,” he said.

Investors should also consider the risk associated with the worst-of payout.

“The Russell has been underperforming the Nasdaq and some people say small-caps are due for a comeback. It’s the opposite with the Nasdaq.”

The Russell 2000 index picked up 7% in the past year while the Nasdaq jumped 23%.

“This is a good note if you don’t think the market is going to move further. It’s for someone who’s leaning toward a range bound view,” he said.

RBC Capital Markets, LLC is the agent.

The notes settled on Monday.

The Cusip number is 78016NE29.

The fee is 0.15%.

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