Scotia’s $36.27 million levered notes offer ‘high’ cap for a short, buffered play, advisers say

By Emma Trincal

New York, March 19 – Bank of Nova Scotia’s $36.27 million of 0% capped buffered enhanced participation notes due June 11, 2025 linked to the Russell 2000 index provide an attractive upside potential without neglecting the downside protection, two positive characteristics especially on a shorter-dated product, advisers said.

If the final index level is greater than the initial level, the payout at maturity will be par plus 200% of the index return, subject to a maximum settlement amount of $1,188 per $1,000 principal amount of notes.

Investors will receive par if the index finishes flat or falls by up to 10% and will lose 1.1111% for each 1% index decline beyond 10%.

Tenor vs buffer

“I like the idea of getting leverage on a short tenor. It’s usually difficult to price when you add a buffer,” said Ken Nuttall, chief investment officer at BlackDiamond Wealth Management.

The note offered the greatest value on the upside with its 18.8% cap.

“You only need 7% a year on your index to cap out,” he said.

Many short-term leveraged capped notes have no downside protection, he said.

“We can argue that 10% is not enough protection for a 15-month note, but at the same time, it’s better than nothing and it’s actually not so bad,” he said.

The leverage on the buffer was to be expected.

“Your upside leverage is being paid by the gearing on the buffer,” he said.

For investors, the note represents a tradeoff between duration and protection with the preference given to the shorter duration.

Reversal play

“Obviously, I would personally prefer to have more downside protection. But I would then have to settle for a longer note. I’d rather keep the term short like it is here,” he said.

Nuttall also liked the choice of the underlying.

“The Russell is expected to perform better. It’s been the underperformer for a while. Since everyone is betting on a comeback for small caps, it may actually happen sooner than expected. Fifteen months may be the right time to do something,” he said.

The timing, however, remained uncertain.

“So far, the Russell is still far behind. The expected rebound has not happened yet. We’re still in a market where the Mag7 outperform,” he added, referring to the “Magnificent Seven,” a group of seven high-growth stocks.

The Russell 2000 index is flat year to date while the S&P 500 index is up 8.5%.

Cost

The 0.94% fee, as disclosed in the filing, was on the high side, according to Nuttall, but he downplayed the issue.

“OK, it’s almost 1% for 15 months. People always get concerned about the fee. But to me the main thing is whether clients are OK with the economics. If they are, they don’t have to worry about how much they are going to be charged,” he said.

“I think it’s a pretty good deal.”

Downside

An adviser agreed.

“There are many things to like in this one,” he said.

“It’s a short-term note. It’s tied to a well-known index, and that’s one index, not a worst-of.

“The Russell is a very unloved benchmark. It offers a much better chance to do well.”

This adviser uses back-testing analysis to assess the notes he may be buying.

He used historical performance data he collected on the Russell 2000 going back to 1987.

Over 15-month rolling periods, the index has been negative 28.2% of the time, he said.

Within that bucket, the return of the underlying fell within the bucket range 14.2% of the time.

“Once you drop below -10%, you get into the gearing zone and the chances of losing money are 14%. That’s a pretty significant risk,” he said.

As the index declines further, the losses compound even more, he added.

More than the gearing though, the buffer size was this adviser’s main objection, at least for some clients.

“If you’re pretty nervous about losing money, the buffer is not going to be big enough.

“Personally, I like the gearing because I don’t have to run into tax issues. Since you can in theory lose 100% of your principal and since it’s longer than one year, you’ll get long-term capital gains treatment,” he said.

Likely to outperform

But the upside payout more than offset the concerns over the buffer.

Going back to his statistics, this adviser noted that investors had a 33.7% chance to see the Russell 2000 finish positive and below the cap, which is the optimal outcome.

“You’re going to outperform anytime you are negative and also anytime you’re up but below the cap. So, you really beat the market 62% of the time,” he said.

The last outcome, which is when the cap is below the index’s return, is associated with a 38.1% probability.

“Even if that happens, you still get almost 15% a year compounded. Nobody should be complaining about that,” he said.

Ticking all the boxes

In conclusion, this adviser expressed a positive view on the security.

“This note hits on all the normal things you would require for a good structured product,” he said.

Those items were the single index versus a worst-of; the leveraged upside; a “high” cap, which the 2x leverage allowed investors to score easily.

“Of course, you always want a note to be uncapped. But I’ve never seen a short-term leveraged note without a cap.

“To have this high a cap on a 15-month with 2-times leverage is really impressive.

“No wonder they got $36 million on this thing.

“This is a really nice note all the way around,” he said.

Scotia Capital (USA) Inc. is the underwriter. Goldman Sachs & Co. LLC is the dealer.

The notes settled on Friday.

The Cusip number is 06417YQ69.

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