Scotia’s $2.46 million dual directional buffered notes on S&P target conservative investors

By Emma Trincal

New York, July 17 – Bank of Nova Scotia’s $2.46 million of 0% dual directional capped buffered notes due July 16, 2025 linked to the S&P 500 index are particularly suitable to investors seeking to protect and hedge the downside, advisers said.

If the index gains, the payout will be par plus the index return, capped at par plus 23.5%, according to a 424B2 filing with the Securities and Exchange Commission.

The payout will be par plus the absolute value of the index return if the index declines by no more than 20%.

Otherwise, investors will lose 1.25% for every 1% that the index declines beyond 20%.

Yield search

“It’s a pretty conservative note. You get a solid return on the downside,” said Ken Nuttall, chief investment officer at BlackDiamond Wealth Management.

The geared buffer did not surprise him.

“We’re starting to see more and more of those gearings. People are jumping for yield these days.”

Higher yields are harder to find as the stock market is trending upward, he said.

“The note offers a good payout considering that your performance is tied to one index only and not two or three,” he said.

In the current market, securing high returns through structured notes has been more challenging than last year.

“We had an issue with a bunch of notes we did last year in October or November yielding 14% or even 16%. They’re all getting called, that makes sense. But now you can’t find 16%. It’s more like 8%,” Nuttall said.

Keeping up

To achieve the higher yields seen last year, this adviser said he employs worst-of payouts.

“We’re looking at off-the-wall indices. We recently did a two-year on the KRE and Nasdaq with a 60% trigger on the principal and a 70% barrier on the coupon. The yield was 16.25%,” he said.

“KRE” is the ticker for the SPDR S&P Regional Banking ETF.

For more conservative income notes, Nuttall said he aims for 10% to 10.25% coupons with 70% barriers at maturity.

“It’s a little bit harder to get this year given the low volatility. We need the market to go down to get higher coupons,” he said.

Seeking higher yields is dictated by a drastic change in the interest rate environment since the Federal Reserve began hiking rates last year.

“You don’t get that much premium over the Fed Funds rate with a 5.5% Treasury yield. It’s not like a year ago when rates were only 1%,” he said.

Defensive play

As a participation product, the Scotia note offered the advantage of a “reasonable” cap, he said.

“You’re getting an equity-type of return at about 12% a year with a relatively protective structure. That’s a good place to be if you’re a conservative investor,” he said.

“On the downside, you’re not going to lose any money if the index is down 20% or less. In fact, you’ll make money with the absolute return. It’s pretty cool.”

One caveat, he said, was the downside gearing.

“We tend to avoid them. People don’t fully understand them. While it certainly helps pricing, we’d rather look for regular buffers,” he said.

Happy with cap

Carl Kunhardt, wealth adviser at Quest Capital Management, said he could use the note for its superior risk-adjusted return compared to a direct investment in the index.

“I love it. That’s exactly the kind of note we’re looking for,” he said.

The adviser said he constantly owns the S&P 500 index in his portfolio as a core piece of his allocation.

“Then the question is: do I want to own it as a note or long? In this case, it’s a no-brainer. I’m better off with the note.

Tradeoff

“Even though there is no return enhancement, I have a cap of 12% a year. Since I expect only 8% for this asset class, I’m happy with the cap. I am not going to be capped out below my expectation.”

But the real benefit was on the downside.

“20%. That’s a huge protection. It’s a buffer, not even a barrier. And by the way, I get the absolute return all the way to 20%. If I’m down 18%, I make 18%,” he said.

For Kunhardt, the gearing was perhaps the only negative aspect of the structure, but a necessary one.

“Nothing is free. The fact that it’s geared at the end is the cost of doing business. You have to pay for the other goodies,” he said.

A good fit

He concluded that the terms of the notes fit his market outlook.

“As you get into 2024, you’re in an Election year. Nothing usually happens during that period. Of course, things could be different, but I don’t anticipate wild swings.

“Over two years, I expect the S&P to give me 8% to 8.5% annually, so the cap is right. The S&P is the cornerstone of my portfolio. Whether the note existed or not, I would be investing in the index. The only thing that matters is that the cap is not too low. In this case, it is well above what I need.

“The downside gives me plenty of room to outperform. I can use the note as a hedge.

“This is a simple, to-the-point note. The benefits by far offset the drawbacks,” he said.

Scotia Capital (USA) Inc. and J.P. Morgan Securities LLC are the agents.

The notes settled on Friday.

The Cusip number is 06417YLQ0.

The fee is 1.5%.

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