Deutsche Bank's capped BUyS linked to index, fund basket offer good equity alternative

By Emma Trincal

New York, Dec. 9 - Deutsche Bank AG, London Branch's 0% capped buffered underlying securities due Dec. 30, 2014 linked to a basket of two indexes and an exchange-traded fund could be used by investors as a substitute for a portion of their equity portfolio, said Suzi Hampson, structured products analyst at Future Value Consultants.

The underlying components are the S&P 500 index, the Russell 2000 index and the iShares MSCI EAFE index fund. Each has a weight of one-third, according to an FWP with the Securities and Exchange Commission.

The payout at maturity will be par plus 1.25 times any basket gain, up to a maximum return of 50% to 55%. The exact cap will be set at pricing. Investors will receive par if the basket falls by 20% or less and will lose 1% for every 1% that the basket declines beyond 20%.

Investment theme

"This is very much a global equity basket with a focus on developed markets," said Hampson.

"The basket diversification helps lower volatility and risk.

"There is Europe, but it's only a third of the basket. Besides, it's a three-year investment, so it takes a longer-term view.

"It offers quite a good upside potential, and you could use it to replace an existing equity portion of your portfolio, for instance some exchange-traded funds that track those regions. This could be a very similar kind of proposition but with lower risk.

"The sacrifice is the three-year term and the fact that you're taking Deutsche Bank's credit risk.

"But it's an attractive alternative to a direct investment in these markets."

Below-average risk

The riskmap, a Future Value Consultants rating that measures the risk associated with a product from zero to 10, is 4.44, at the lower end of the scale.

It compares well with the 4.70 average riskmap for products of the same structure type - in this case, all leveraged notes.

The riskmap is even lower than the average riskmap for all products, 5.16, which includes a significant number of reverse convertibles, she said.

The riskmap compares the average product underperformance (relative to cash) with the average underperformance of five sample assets of different volatility levels.

The riskmap is the sum of two risk components: market risk and credit risk.

"With this product, the lower market risk is what diminishes the riskmap," she said.

The notes received a 3.18 market riskmap, compared with an average of 4 for the same product type.

"Market risk is more subdued partly because of the underlying," she said.

"We get a lot of products linked to more risky assets, such as a single stock or even a fund or index based on more volatile asset classes, such as emerging markets or commodities.

"In addition to that, you have a basket, which dampens volatility quite a bit."

The type of downside protection offered by the notes explains the better market riskmap when comparing the product to products of the same type, which incorporate all leveraged notes.

"You have a 20% buffer here. It's not that common, and even if it's a three-year, 20% is still a big buffer compared to most leveraged notes that revolve around 10%," she said.

"With a 20% buffer, not only do you have more room for the basket to drop before you can actually take a loss, but even below that 20% point, you're still outperforming a direct investment," she said.

She took the example of a 30% drop in the level of the basket at maturity. A direct investor would lose 30% while investors in the notes would only lose 10%.

Besides the buffer amount, the protection type gives this product an advantage over other products, whether they incorporate leverage or not.

"You have notes with a smaller buffer or notes with a barrier instead of a buffer; in some cases, for instance with other types of leveraged products, you may not even have any downside protection at all," she said.

Credit and tenor

Contrasting with the low market risk, this product displays a higher credit risk than average with a 1.27 credit riskmap. The average credit riskmap of all products and the average for the same type of products are 0.54 and 0.70, respectively.

Hampson looked at Deutsche Bank's credit default swap spreads of 220 basis points and concluded that the credit riskmap is not directly related to this issuer's creditworthiness.

"It's not a bad spread for a European bank or even compared to many U.S. banks well above 300 basis points," she said.

"I think the tenor is the factor here. You have a three-year product. It's kind of double the usual term.

"If the credit portion of the riskmap is higher than the average, it's due to the longer term rather than the credit of Deutsche Bank."

Good cap

The notes received a high return score of 7.48, which means that the return compared to the risk is high, said Hampson.

The return score on a scale of zero to 10 is Future Value Consultants' opinion of the risk-adjusted return under reasonable and consistent forward-looking assumptions for underlying asset evolution. In the calculation of this score, Future Value Consultants use five key assumptions: neutral assumption, high- and low-growth environments and high- and low-volatility environments. The firm calculates a risk-adjusted average return for each assumption. The return score is the best of these five returns.

The notes' return score is better than the 7.09 average score for those products of the same type and even better than all products, which averaged a 6.27 return score.

"It looks good," she said.

The 50% to 55% cap, which is equivalent to 14.47% to 15.73% per annum on a compounded basis, contributes to the attractive return score, she said.

"Often, leveraged products see their returns eroded by the cap and you might do better investing directly in the underlying asset than in a note, which restricts your return," she said.

"But here, at 15% per year, the cap is high enough because of the low gearing. You get a good range of return," she said.

The return score is derived from the probability of return outcomes calculated by Future Value Consultants using a Monte Carlo simulation and displayed in a chart across different return buckets.

Investors in these notes have a two-thirds probability of generating a positive return at maturity with a 26% chance of getting an annualized rate of return in the 10% to 15% bucket. The odds of losing money are one-third, which encompass a 13% probability of losing more than 15%.

"This is a quite reasonable spread of returns," she said.

"If you had an investment portfolio with these types of assets, chances are you would be targeting a lower return than 15% per year. The slight 125% gearing gives you a fair chance to outperform the basket," she said.

Price, overall

Future Value Consultants' estimate of the total costs taken out of the product from direct fees and profit margin on the underlying derivative is measured by its price score on a scale of zero to 10.

The notes received an 8 score for the price, more than the 7.18 average score for similar products.

"This is definitely the best score compared to others. It shows that you get good value for your money," she said.

"The issuer has spent more money on the options, and the more the issuer spends on the options, the more it provides value to the investor.

"There is also a term factor here. Longer-dated notes tend to score better on the price scale because there is more time to spread the fees. But it's still quite good."

Future Value Consultants offers its opinion on the quality of a deal with its overall score, the average of the price score and the return score.

The notes have an overall score of 7.74, compared with 7.14 for the same types of products and 6.36 for the average of all products.

"On all the scores, this product has done better. The big difference is the price score here, which suggests that you're getting better terms than the average.

"Both the cap and the buffer make this product quite appealing," she said.

Deutsche Bank Securities Inc. is the agent.

The notes will price on Dec. 23 and settle on Dec. 30.

The Cusip number is 2515A1F63.

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