BMO’s $7.81 million 6.4% buffered autocall on S&P, Russell aimed at conservative yield-seekers

By Emma Trincal

New York, Jan. 25 – Bank of Montreal’s $7.81 million of 6.4% autocallable buffer notes due July 24, 2023 linked to the least performing of the S&P 500 index and the Russell 2000 index provide guaranteed income over a short duration with relatively moderate risk, a financial adviser said.

The interest is payable semiannually, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called at par if the least performing index closes at or above its initial index level on any semiannual observation date.

If the notes are not called and the least performing index return is above 80% of its initial level, the payout at maturity will be par. Investors will lose 1.25% for each 1% loss beyond the 20% buffer.

Yield enhancement

“It seems like a pretty benign structure,” said Jonathan Tiemann, president of Tiemann Investment Advisors.

“There’s a relatively low degree of risk. You’re selling all of the upside for a good coupon and some protection on the downside.

“What this really is about is creating the 6.4% annualized income stream. It’s not about upside participation in the market although you do have exposure to the market on both the call and the downside.”

Exposure, no participation

The exposure on the call side relates to the requirement that both indexes be above their respective initial level on the determination date in order for the call option to be triggered, he noted.

“On the downside though it only takes one index to generate a loss although you’re not going to get hurt much,” he said.

Despite the gearing, the buffer was large enough to mitigate a significant part of the market risk, he said.

He offered an example: a 40% decline in the worst-performing index would generate a 25% loss due to the gearing.

“That’s a dramatic example. But it shows that even with a big drop, your losses would be much lower. In fact, you wouldn’t even lose 25%. You would get a third of it back because you pocket a 6.4% coupon,” he said.

Additional cushion

The total return of the notes, which is 9.6% over the period, would lower the loss amount to 15.4% from 25%, a 38% cut, he explained.

“It’s actually a relatively low-risk investment. If you have a small risk budget and want to get that type of yield, it’s a good way to do it,” he said.

Tiemann said the 18-month tenor was also a plus.

“I like that it’s a short-term note. I always like to have more options to reinvest.

“You also have a call after six months followed by another one in one year. Investors are pretty likely to be called and if it’s the case, that’s not the worst thing that can happen to you in the world,” he said.

Yet short-term durations have their drawbacks. The work of finding compelling yield can be time-consuming especially with shorter-dated notes, he said.

“Doing all the paperwork and due diligence for a note of that nature...I’m not convinced it’s worth the effort, but in terms of the structure, the note is a solid choice for people seeking yield,” he said.

Russell vs. S&P

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, said the timing of the notes was not optimal.

“Most likely, your exposure is going to be to the Russell 2000, which is not doing very well. Small caps have been lagging for the past year.

“I don’t know if it’s going to change. But we’re certainly facing a lot of problems.”

This adviser does not favor worst-of payouts in the first place. But betting on the Russell versus the S&P was not a good idea, he said.

“Most likely you’re going to get the Russell.”

For the year to date, the performance gap between the two benchmarks remained muted. The Russell 2000 index and the S&P 500 index are down 10.65% and 8.6%, respectively.

Over the past 12 months, however, the Russell has dropped 6.7% while the large-cap benchmark is still positive, posting a 13% gain.

Fed’s tightening

“I don’t love the construct of this note. You’re talking about 18-month. Unless the Fed doesn’t raise rates for the next two years, we’re in for a bumpy ride,” he said.

The market enjoyed years of above-average returns and low volatility due in large part to the Federal Reserve’s accommodative monetary policy. But as the central bank plans to raise rates and taper its bond purchases this year, the easy-money environment is about to evolve into something less predictable.

“The market is going to get a little rocky without the Fed’s involvement,” he said.

“I’m not sure a 20% buffer is enough if we’re going into a recession.”

Too short

In general, small-cap stocks over the long term are more volatile and in a good way, he said.

“They tend to perform better,” he said.

But the note is too short in duration.

“Given the economy that we have with high inflation and coming off of Covid without a meaningful rebound, small caps will be less able to withstand the volatile economy. Big companies can afford to have a bad quarter or two. Small ones can’t.”

“I wouldn’t feel comfortable having exposure to this index at a time when money is going to be pulled out of the system,” he said. “In addition to that, you have geopolitical risks. Global risks are mounting.”

BMO Capital Markets Corp. is the underwriter.

The notes settled on Monday.

The Cusip number is 06368GGF8.

The fee is 0.05%.

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