Advisers shy away from Citi’s $2.31 million notes on Dow, ARK due to ETF’s volatility

By Emma Trincal

New York, March 8 – Citigroup Global Markets Holdings Inc.’s $2.31 million of 0% barrier securities due March 6, 2025 linked to the least performing of the Dow Jones industrial average and the Ark Innovation ETF show an attractive upside payoff, but advisers said the extreme volatility of the ETF creates too much risk for investors despite its recent sell-off.

If each underlier finishes at or above its initial level, the payout will be par plus 2.82 times the return of the least-performing underlier, according to a 424B2 filing with the Securities and Exchange Commission.

If the least-performing underlier finishes below its initial level but at or above its final barrier level, 80% of its initial level, the payout at maturity will be par.

Otherwise, investors will lose 1% for each 1% decline of the least-performing underlier from its initial level.

Innovation

“The ARK already had a huge sell-off. The Dow is down too but not as much. Anyone buying the note has to assume there will be a recovery. You buy at a low entry point and that’s the rationale,” said Tom Balcom, founder of 1650 Wealth Management.

“I’m not sure it would be my view.”

ARK Innovation is an active ETF managed by ARK Investment Management LLC founder Cathie Wood, a former portfolio manager at AllianceBernstein, who specializes in picking stocks of innovative companies across sectors.

ARK Innovation, which is the firm’s flagship, drew large capital inflows with a 683% return from its inception at the end of 2014 to its peak in February 2021. Since then, the fund dropped 64% to $56.62, its closing price on Tuesday. Tuesday’s closing price is already 17% off the $68.31 initial level on the notes’ trade date.

High volatility

“Cathie Wood continues to be bullish on her bets, especially with electric vehicles. She has almost 10% in Tesla,” said Balcom.

“If she’s right, the worst-of would be the Dow.

“But the real risk is that her stocks continue to plummet.

“This is a highly volatile, highly concentrated ETF.”

The number of holdings in the fund varies between 35 and 55, according to the company’s website.

The implied volatility of the ETF is 86.58% compared to 25.69% for the S&P 500 index.

“If you’re bullish, you may argue it’s an interesting note because of the no-cap plus leverage on the upside. Personally, I’m not comfortable with that level of volatility,” he said.

A modern Janus 20

The ARK Innovation ETF reminded Balcom of the Janus Twenty, a popular growth fund in the1990s.

“Same strategy: they picked a concentrated portfolio of high-flying stocks, generating a stellar performance until the fund plummeted. It was the ARK of the late 1990s,” he said.

Balcom said the volatility of the ETF helped the pricing of the notes.

“I like the terms a lot. You have 2.8x leverage and no cap on a three year. They used the worst-of and the volatility of the ETF to price those terms,” he said.

But he said he would not consider the notes.

“Cathie Wood is a very passionate stock-picker. If you buy the notes and don’t breach, it’s good. But the ARK is just too volatile for me,” he said.

Goodbye growth

Another financial adviser also objected to the notes.

“The problem here is the barrier. Eighty percent is not enough even for the Dow and certainly for the ARK, a very volatile fund. The holdings in the ARK are significantly overvalued,” this adviser said.

The ARK Innovation ETF was the most likely to be the worst-of, he added.

“It’s a pure growth portfolio. Growth has been a winning strategy over the past decade, but there is a shift right now. We have begun to move the other way,” he said.

For this adviser, who said he studies historical market cycles, growth and value seem to alternate every decade or so.

“After tech stocks collapsed in the early 2000’s, they performed poorly for the rest of the decade. Value did better until 2007. In 2010, growth came back until 2021. Now, the pendulum is swinging toward value again.

“So, I wouldn’t bet on a portfolio of growth stocks even after the fund’s pullback. It can certainly drop more, much more,” he said.

Downside risk prevails

The exposure to the Dow Jones industrial average posed a lesser risk.

“The Dow is a mix. It’s a little bit more balanced than the ETF. But it’s still overpriced,” he said.

This adviser defined the two main risks associated with the notes.

“You could be holding the notes for three years and finish up slightly up but kind of flat or with very small gains if we have a big drawdown. In that case, the leverage is not going to help you much,” he said.

“But given the volatility and valuation of the ETF, to me the biggest risk is to lose money. It’s the most likely outcome.”

The notes will be guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes settled on Friday.

The Cusip number is 17330AJV5.

The fee is 0.75%.

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