JPMorgan’s $315,000 capped leveraged notes on EM ETF offer better value than U.S. stocks

By Emma Trincal

New York, Jan. 7 – JPMorgan Chase Financial Co. LLC’s $315,000 of 0% capped accelerated barrier notes due Jan. 5, 2026 linked to the iShares MSCI Emerging Markets ETF give investors a more valuable exposure to equities than U.S. stocks given the overextended valuations seen in the domestic market, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

If the ETF finishes above its initial value, the payout at maturity will be par plus 1.5 times the return of the ETF, up to par plus 42.9%, according to a 424B2 filing with the Securities and Exchange Commission.

If the ETF falls but finishes at or above its barrier level, 70% of its initial value, the payout will be par.

If the ETF finishes below its barrier level, investors will be fully exposed to the decline of the ETF from its initial value.

Four years

“The four year is probably a good thing. The longer the better. It gives you time to recover from what's likely to be a global bear market,” said Kaplan.

The value-oriented portfolio manager said he likes emerging markets in comparison to U.S. market, which he views as “overpriced.”

“You don’t want to pay too much for a stock. Valuations in emerging markets are not nearly as bad as they are here, especially with big U.S. companies like Apple and Microsoft,” he said.

In the current market, longer maturities are more defensive.

“We’re heading for a bear market. In fact, I believe we’re already in one,” he said.

“Note that the Nasdaq hit an all-time high just around Thanksgiving but has so far failed to revisit that level.

“Investors are piling in overvalued stocks. Inflows in equity funds have never been that high. Meanwhile insiders’ selling activity is intensifying, reaching levels not seen in a long time.

“So, I expect a severe drop especially for large-cap growth stocks that are extremely overbought.

“In this scenario, four years is enough time for your underlying to recover because bear markets usually last only two to three years. Within four years, you should be able to benefit from a decent rebound.”

Longer-dated notes penalize noteholders in relation to shareholders as they are not entitled to receive dividend payments.

In this case, the opportunity cost was contained, he said.

“The dividend is only 1.5%. While it’s four years, you’re not giving up a big dividend.”

Rich, not rich

The holdings and country breakdown of the ETF offered both positive and negative characteristics. But overall, investing in emerging markets was a more opportunistic strategy than buying domestic stocks, he said.

“The iShares Emerging Markets is a mixed bag because you have cheap countries like China, Brazil and some other South American countries, where you can find attractive bargains. But other countries are not cheap. India is not cheap and it’s close to 13% of the portfolio.”

The ETF’s constituents also presented a mixed picture, he added.

“Names like Alibaba and Tencent are very cheap. I like these stocks for their low valuations.

“But Taiwan Semiconductor, which is the biggest holding with a 7.5% weight, is an extremely overpriced stock.

“Samsung also is rather overvalued.

“So, you have a portfolio comprised of cheap stocks and pricey stocks.”

Big cap

Part of the problem was the market-capitalization weighting of the fund.

“Market cap weightings are flawed. They overweight overvalued stocks and underweight undervalued stocks,” he said.

“The cheaper companies, those you want to be looking at, tend to have smaller weightings.”

He pointed to the case of Alibaba Group Holding Ltd. Its share price fell by 60% from the fall of 2020 but the name makes for only 3% of the fund.

“It's probably better to invest in equal-weighted indexes or indexes with weights based on fundamental factors, such as profitability,” he said.

“There are some stocks with low P/Es in the ETF. But because of the market-cap weighting, the fund is still expensive. It should be much lower in price.”

Unlikely knock out

Despite those limitations, Kaplan said the downside protection of the notes was relatively satisfying.

Looking at a five-year chart, he pointed to a low in March 2020 at $29 a share. Less than a year later, the ETF peaked at $57.19.

“Now it’s at $49. It’s down from its high but it’s still higher than the March 2020 bottom,” he said.

“On the other hand, the big sell-off of March 2020 was extreme. It doesn’t that often go down that much.”

The ETF closing price on the trade date was $49.09 setting the barrier price at $34.363.

“It gives you enough protection. You would need to see an extreme event happen at the end of four years to take a loss.

“Of course, nothing is guaranteed. But at least you get a reasonable barrier.”

Decent cap

Kaplan said he also liked the cap. On a compounded basis, investors can earn up to 9.3% per year.

“It’s not a huge return but it’s a leveraged payoff, so you have to give up something,” he said.

“They could have done no leverage with a higher cap.

“The leverage helps if you don’t expect a very big return. It will enhance your gain and if the ETF doesn’t go up a lot, you can easily outperform.

“If you’re super bullish you shouldn’t be capped.”

For the portfolio manager, a very bullish trend was unlikely.

Moderately bullish

“The cap is fairly reasonable. If, as I expect, U.S. markets drop significantly, it will be difficult for other parts of the world to have big gains.

“So that particular kind of structure might work better for investors.”

“Stocks like Alibaba and Tencent are not likely to go through massive sell-offs because they already had a series of declines.

“But names like Taiwan Semiconductor that are just as overpriced as Microsoft or Apple are likely to be hit harder.

“So overall, the chances for the ETF to exceed the cap in four years aren’t that high.”

In conclusion, the portfolio manager said he liked the structure.

“The use of the leverage, cap and barrier is a reasonable mix and the fact that it’s a four-year term is also a good thing. I like the combination of those factors.”

The notes are guaranteed by JPMorgan Chase & Co.

The agent is J.P. Morgan Securities LLC.

The notes (Cusip: 48133CFL1) settled on Jan. 4.

The fee is 0.5%.

© 2015 Prospect News.
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