Bank of Montreal’s notes on Commodity index offer leveraged bet on commodities, full hedge

By Emma Trincal

New York, Oct. 25 – Bank of Montreal’s 0% market linked notes due Oct. 30, 2026 linked to the Bloomberg Commodity index provide leveraged exposure to commodities with full downside protection.

If the index gains, then the payout at maturity will be par plus 200% of the return of the index capped at par plus 30%. Investors will receive a minimum payout of par, according to an FWP filing with the Securities and Exchange Commission.

“We’re actually showing this note right now. We’re getting pretty good traction,” a sellsider said.

The low volatility of the underlying helped pricing, he added.

“It’s basically a zero-coupon bond with three at-the-money calls. When vol. is low, calls are cheaper.

“It’s a good note if you want access to the commodity asset class,” the sellsider said.

Energy heavy

A financial adviser said the principal-protection was attractive. But he compared the possible outcomes with an investment in the risk-free rate.

“The Bloomberg Commodity is mostly oil and gas plus mining,” he said.

Combined, those two sectors have a weighting of approximately two-thirds. Energy alone makes for a third of the index.

“Commodities should continue to be strong in the next few years unless we go into a major recession, which is always possible,” he said.

Given current valuations, the outlook for energy was very different than for other sectors.

“The upside for energy is light,” he said.

The energy sector has outperformed the most part of the year, rallying 25% from March to mid-September.

It has been more volatile since then.

“Mining has some upside,” he said.

Cost assessment

The worst-case scenario, this adviser said, would be a zero return after holding the notes until maturity.

“You don’t lose your principal. But you’ve wasted your time for three years,” he said.

He gave an estimate of the cost of the lost opportunity comparing the notes with an investment in a three-year Treasury bond.

“If you don’t get any return from your note, you’re losing the 5% a-year you would get from Treasuries,” he said.

He looked at the probabilities of outcomes comparing the Treasury position with the 10% annualized return investors may get at best if they hit the 30% cap.

“You have to decide if you want 5% a year guaranteed or the potential to earn twice that but without the guarantee,” he said.

“If the odds are 50/50, I don’t think it’s worth taking the risk with the note.”

The note was “OK,” but this adviser said he would not consider buying it for his clients.

“To me, a lot of those things have become unappealing with rates as high as they are. It would be very different if we were still in a zero-interest rate environment,” he said.

BMO Capital Markets Corp. is the agent.

The notes will price on Friday and settle on Oct. 31.

The Cusip number is 06375MEA9.

The fee is 3%.

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