BofA’s $1.03 million deal on basket seen as intriguing with its bond component, high leverage

By Emma Trincal

New York, Nov. 27 – Advisers were intrigued by a note tied to a basket mixing equity and bond components as well as its high and unlimited upside exposure.

BofA Finance LLC priced $1.03 million of 0% enhanced return notes due Nov. 22, 2028 linked to an unequally weighted basket consisting of the S&P 500 index with a 40% weight and the iShares Core U.S. Aggregate Bond ETF with a 60% weight, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 5.3 times any basket gain.

If the basket finishes at or above its barrier level, 70% of its initial level, the payout at maturity will be par.

Otherwise, investors will lose 1% for each 1% decline of the basket from its initial level.

Bond ETF

Ken Nuttall, chief investment officer at BlackDiamond Wealth Management, pointed to what he believed made the product relatively unusual.

“We usually don’t see notes tied to bond funds or bond indices. Historically, it’s because there’s not enough volatility for it. But since the beginning of November, rates have been dropping a lot after going up a lot for a while. As a result, volatility in the bond market has been picking up.

The Federal Reserve has raised the target range for the Federal Funds rate by a total of 525 basis points since March 2022. On Oct. 22, the 10-year Treasury yield hit 5% for the first time since 2007. It traded at 4.39% on Monday.

The bond market started to rally after Fed chair Jerome Powell sent a more dovish message to close the two-day FOMC meeting on Nov. 1-2, he said.

Nuttall mentioned another factor behind the scarce use of fixed-income assets.

“We don’t see a lot of bonds in notes because most desks are equity-centric and not so much bond-centric,” he said.

60/40 strategy

The underlying basket in the notes was useful for asset allocators, he added.

“It’s a variation on the 60/40 portfolio. You can use it as a replacement for this strategy. It’s just a little bit more conservative since they’ve slightly changed the allocation,” he said.

60/40 portfolios allocate 60% to equities and 40% to bonds, which is the reverse of the underlying basket.

Leverage

“The only thing with this note is that you don’t get the coupon. That’s why you get the leverage,” he noted.

The high leverage factor is also designed to offset the modest performance of the bond ETF, which is up only 0.69% year to date.

“It’s not awesome when you compare it to 18.5% for the S&P 500. But again, it’s an asset allocation play, and you get 5.3x the upside, no cap,” he said.

Protection

Nuttall also liked the downside protection.

“70% is pretty good. I was actually expecting 80% because this thing will always end up positive after five years.

“At some point, we thought of asking for a shorter term like a three-year and maybe get 3x leverage. But it might be too short of a period. AGG had a negative performance over the past three years.”

The iShares Core U.S. Aggregate Bond ETF is listed on the NYSE Arca under the ticker “AGG.”

“It’s a very decent barrier. Overall, it’s a great note,” he said.

Entry points

Steve Foldes, wealth manager and founder of Evensky & Katz / Foldes Financial Wealth Management, also expressed interest.

“With the 5.3x uncapped leverage, you can get outstanding returns. It’s almost too good to be true,” he said.

A basket returns of 50% over five years for instance would generate a 265% gain for investors.

“These are excellent results, and the entry points are attractive,” he said.

“The S&P is 5.6% off its all-time high of January 2022. The AGG is also trading at a discount.”

The iShares Core U.S. Aggregate Bond ETF hit a one-year low on Oct. 23 and is 5.4% below its February high.

“They’re both trading with a more than 5% discount from their previous highs,” he said.

Superfluous

Foldes said he was comfortable with the issuer’s creditworthiness. The 0.6% underwriting fee, as disclosed in the prospectus, was also “satisfactory.”

The only downside found in the note was the barrier.

“That’s the superfluous part,” he said.

“You don’t need a 70% barrier on a five-year note tied to a bond index. And it would be very unusual for the S&P to be down on a five-year period of time.

Tradeoff

“I would do away with the barrier.”

In exchange for the elimination of the barrier, Foldes said he would seek to increase the upside leverage.

Another potential tradeoff could have been a shorter duration. But in this case, he would rather maintain the longer tenor.

“I don’t mind a five-year if I have a high leverage multiple like this one. Don’t shorten the note. Just add more leverage if possible. A higher number would be fantastic,” he said.

Even as is, Foldes said the structure was compelling.

“This is a very interesting note, one that will make money for clients,” he said.

The notes are guaranteed by Bank of America Corp.

BofA Securities, Inc. is the selling agent.

The notes settled on Nov. 22.

The Cusip number is 09710P7E0.

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