BMO’s $7.69 million notes tied to S&P 500 offer defensive play, but risk still high for bears

By Emma Trincal

New York, Jan. 9 – Bank of Montreal’s $7.69 million of 0% market-linked securities with absolute return and buffered downside due Jan. 5, 2026 linked to the S&P 500 index provide a hedge to investors seeking exposure to the market with less risk, an adviser said. But a more bearish portfolio manager argued that the protection will not be sufficient in a bubble burst scenario.

If the index finishes flat or gains, the payout at maturity will be par plus the return, capped at par plus 21.65%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will gain 1% for each 1% decline if the index declines up to 15% and will lose 1% for every 1% that the index declines beyond 15%.

Cap

“This is a great note. I like that. You get the absolute return on the downside and a nice buffer,” said Tom Balcom, founder of 1650 Wealth Management.

The limitation of gains on the upside was tolerable.

“The 21.65% cap is about 10% a year compounded, and that’s in line with the historical performance of the S&P.

“Since we already had a nice run last year, how much more should you expect? The cap seems pretty reasonable to me,” he said.

Excess return

The real appeal of the note was on the downside. The combination of a traditional buffer and the absolute return gave investors room for excess returns over the benchmark.

“If you’re down 15%, you’ll outperform by 30%, which is outstanding,” he said.

“If you’re down 16%, you only lose 1%. Even below the -15% level you’ll outperform because it’s a buffer, not a barrier.”

Hedge

The note could be employed as a tool to reduce losses in a declining market.

“This is a pure hedge. I always like those notes because you can’t forecast the S&P two years from now or for any timeframe for that matter,” he said.

The absence of any return enhancement on the upside was part of the tradeoff for gaining a more conservative structure.

“The whole point is to hedge, and it does that. It provides the downside protection and the absolute return. But in exchange your return is capped, and you’re just one-to-one on the upside,” he said. “That’s what clients need to understand. In order to be able to outperform in a down market you need to give up some of the potential gains.”

Neither bear nor bull

As such, the note was not designed for bulls.

“If you want pure S&P exposure, you buy the S&P.

Balcom did not consider the note to be bearish, however.

“The cap is pretty good. If you can get 10% a year, I don’t think you can call it a bear play. It’s a defensive play that gives you exposure to the market with less risk.

“I like it,” he said.

Bubble alert

Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments, had a different view based on his bearish market outlook, especially over the two-year timeframe.

“In two years, we’re likely to have a much bigger drop than 15%. A 15% buffer is not giving you much protection if the market drops 50%,” he said.

Kaplan said the risk of a severe downturn is high now due to the current “AI bubble,” characterized by a small number of AI stocks driving most of the positive performance of the S&P 500 index.

“All bubbles end up bursting. We just don’t know the timing and the details. But if this one follows the pattern of other well-known bubbles of the past, you can easily expect the index to lose at least half of its value,” he said.

He cited among the most famous bubble bursts the stock market crash of 1929 following the industrial boom of the 1920’s; the “Nifty Fifty,” which was a group of fifty large-cap stocks posting strong gains in the 1960s and 1970s before the bear market of 1973-74; and finally, the dot.com bubble in the beginning of the century.

The notes priced at an initial index level of 4,783.35 last month, which he noted was less than 1% below the S&P’s all-time high of January 2022.

“You’re getting in at the worst possible time. You’re also getting out at the worst time. In two years, we may still be at or close to the bottom,” he said.

Wells Fargo Securities LLC is the agent.

The notes settled on Jan. 3.

The Cusip number is 06375ML37.

The fee is 2.585%.

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