Bank of Montreal's digital notes on iShares Russell 2000 offer range-bound bet on small caps

By Emma Trincal

New York, March 3 - An 18-month note issued by a Canadian bank offers exposure to small caps to investors who are neither very bullish nor very bearish on the asset class, sources said.

Bank of Montreal plans to price 0% buffered bullish digital return notes due Sept. 28, 2012 linked to the iShares Russell 2000 index fund, according to a 424B2 filing with the Securities and Exchange Commission.

If the fund return is positive, the payout at maturity will be par plus the 11.3% digital return.

Investors will receive par if the fund falls by 10% or less and will lose 1% for every 1% that it declines beyond 10%.

In a range

Steve Doucette, financial adviser at Proctor Financial, said that the notes are for investors who see small caps trading range-bound and who believe that the economic cycle has moved far enough in the direction of a recovery.

"This is designed for people who see small caps trading in a range from down 10% to up 11%. They may believe that at this stage of the recovery cycle, large caps are starting to take over," Doucette said.

Uncertainty

But Doucette said that he found the strategy risky.

"You have to really believe that large caps are going to outperform small caps. And in a way, it has already happened. But whether this will continue is anybody's guess," he said.

"And you never know if the whole market is not going to pull back."

Capped gains

Doucette added that he objected to the asymmetrical nature of the structure.

As stated in the prospectus, investors' gains are limited to the digital return. As a result, the digital return of 11.3% is the equivalent of a cap. On the downside, however, investors can lose up to 90% of their principal.

"You're capped on the upside, and you have unlimited downside. I wouldn't find this note of particular interest because of that," he said.

Asset allocation

On the other hand, Matt Medeiros, president and chief executive of the Institute for Wealth Management, said the structure offered a "fair return relative to the risk."

"This would not be for bullish investors, otherwise you would invest in the fund. Rather it's designed for people who have a neutral to positive view on small caps," he said.

"It's an interesting product for someone who is looking for small cap exposure but doesn't want the full risk of this asset class," he added, noting that his comments were limited to the structure. "I'm not familiar with the issuer, and looking at credit risk would be the first thing you do."

Medeiros said that he was overweight large caps and underweight small caps in his overall portfolio.

"This note would fit in our portfolio. The question is not whether to invest or not in small caps but how much you weight the asset class. You don't want to abandon small caps," he said.

The notes (Cusip: 06366QCS4) are expected to price on March 28 and settle on March 31.

BMO Capital Markets Corp. is the agent.

© 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.