CIBC’s $7.04 million of notes on Bloomberg Commodity index offer diversification, hedge

By Emma Trincal

New York, July 24 – Canadian Imperial Bank of Commerce’s $7.04 million of 0% capped Market Index Target-Term Securities due July 31, 2026 tied to the Bloomberg Commodity index provide investors with exposure to a volatile asset class with a high potential return and full downside protection, two features that may fit well in a diversified portfolio, advisers said.

The payout at maturity will be par of $10 plus any index gain, subject to a maximum return of par plus 95%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index falls, the payout will be par.

Not overweight energy

Steven Foldes, wealth manager and founder of Evensky & Katz / Foldes Financial Wealth Management, said the note was attractive for the most part.

“We like the fact that you can get exposure to an asset class that typically shows a low correlation with stocks and bonds. Having diversification through commodities in a portfolio is a good thing,” he said.

The diversification within the index itself based on the weighting of each sector component was also advantageous.

“We like the weightings of each sub asset class in the index,” he said.

The top three are energy with a 29% weighting: precious metals with a 21% weighting; and grains/oilseeds with a 20.75% weighting.

“Most commodity indices are overweight energy. This one is not. That for us is a positive,” he said.

Some commodity indexes have energy weightings as high as 70% to 80%, he noted.

“You’re getting diversification across other asset classes such as stocks and bonds. But your index itself is also diversified across the different groups of commodities,” he said.

Entry point

Another attractive aspect of the deal was the initial level of the index when the notes priced last week.

“Pricing is good,” he said.

The deal struck at 104.52. This initial level was 23% off the 135.43 peak of June 2022, which itself marked the highest point since April 2014.

“You’re not pricing this note at the top of the range, that’s for sure, which is a good thing,” he said.

Cap, term

The cap was also noteworthy.

“The 95% capped maximum return is also very attractive. You’re getting a compounded return in excess of 30% a year before being capped out. I don’t think anybody would complain about that,” he said.

The tenor may be the weak spot.

“The terms are reasonably attractive. We don’t love the three-year term, and the 75 basis points annual fee is high. But on the other hand, we’re mindful of the fact that we don’t lose any dividends,” he said.

If he had to restructure the note, Foldes said he would ask the issuer to reprice it on a two-year term to find out what cap he could get.

Protection vs. volatility

But the best part of the structure was the 100% principal protection against market risk. This benefit allowed investors to offset the most concerning aspect of the asset class.

“There is good news and bad news,” he said.

“The bad news is the fact that commodities are more volatile than stocks. And unlike stocks, commodities don’t always revert to the mean. You could stay negative for some time in the commodity space.”

The “good news” is the principal protection.

“If for any reason the index declines, you are not going to lose any money.

“Eliminating the downside risk is very nice with a volatile asset class.

“You get an asymmetrical return with zero downside risk and a 32% cap per year,” he said.

The bad news

But Foldes pointed to one important aspect of the structure, which was the unfavorable tax treatment.

Holders of principal-protected notes such as this one are subject to ordinary income tax.

“If you have a substantial gain and are in a high tax bracket, almost 40% of your profit is going to go to pay taxes,” he said.

“That’s the consequence of the ordinary income tax treatment as opposed to capital gains which are half that.”

Another downside was that noteholders have to pay income tax each year even though they do not receive any income. In addition, the tax payments have to “come out of pocket” because the funds will not be available from the note, he said.

“That tax story is not a happy one,” he said.

One solution could be to put the note in a retirement account, which would provide tax-deferred or tax-exempt benefits, he said.

“Aside from that, there’s a lot to like about this note. You’re buying very much toward the lower range of the index; the cap is very high; your principal is guaranteed.

“Any investor seeking a diversified portfolio should consider this,” he said.

On paper only

Carl Kunhardt, wealth adviser at Quest Capital Management, held a more ambivalent view.

His decision about using the note or not would depend on the answer to a broader question.

“Do I want to use alternative investments in the portfolio? Well in the past two years, we haven’t,” he said.

Kunhardt said he used to allocate up to 10% to alternative investments, which in his portfolio included commodities and real estate.

His allocation decision then was the result of reading research papers establishing the low or even negative correlation between alternative investments and the other asset classes, such as cash, stocks and bonds.

“On paper, it works wonderfully,” he said.

“In real life, it didn’t work at all. Both in 2008 and during the pandemic, alternative investments didn’t do anything to the portfolio. In many cases it hurt our returns.”

Alternative to alternatives

But if Kunhardt decided to use alternatives, the note would provide a very attractive approach, he said.

“Alternative investment should give you two benefits: return enhancement and hedge. With this note, you check both boxes,” he said.

While the note offered no leverage, the cap was high enough to meet the qualification of “return enhancement,” he said.

And the principal-protection provided a tangible hedge.

“Typically, you hedge with cash and bonds, but those assets will dampen your return. But with a 95% cap, you’re not capping your return. If you think you are, you’re being greedy,” he said.

Kunhardt believed the term was a bit too long.

“Three-year exposure to commodities to me is an eternity. I’d rather have a one-year. You can more readily get an outlook within the next 12 months when it comes to commodities, an asset class that is highly impacted by the political and regulatory landscape,” he said.

Overall, Kunhardt summarized his view as “agnostic.”

“If you don’t invest in alternative investments, why bother? But if you do, then this is not a bad way to do it,” he said.

BofA Securities, Inc. is the underwriter.

The notes settled on Thursday.

The Cusip number is 13607Y469.

The fee is 2.25%.

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