Scotia’s $33.04 million notes on Invesco ETF to reduce big tech exposure, concentration risk

By Emma Trincal

New York, May 7 – Bank of Nova Scotia’s $33.04 million of 0% capped Leveraged Index Return Notes due April 24, 2026 linked to the Invesco S&P 500 Equal Weight ETF offered mildly bullish investors in the large-cap space a way to minimize Big Tech exposure and concentration risk, advisers said.

If the ETF return is positive, the payout at maturity will be par of $10 plus 200% of the ETF return, subject to a maximum payout of par plus 20%, according to a 424B2 filed with the Securities and Exchange Commission.

Investors will receive par if the ETF declines by 10% or less and will lose 1% for every 1% that it declines beyond 10%.

Issuers have multiplied the number of deals tied to the Invesco S&P 500 Equal Weight ETF (ticker: “RSP”) over a year, a financial adviser noted.

“Clients use the RSP to reduce their exposure to the Mag7 or I should say the Mag 5,” said Tom Balcom, founder of 1650 Wealth Management.

Smaller club

The “Magnificent Seven” are the top large-cap growth stocks, which have driven the AI rally.

Those names are Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla. But with Apple and Tesla subject to steep losses this year, some analysts have suggested reducing the “Magnificent” club to five members.

Tesla for instance has lost 40% of its value since its July high.

The Magnificent Five still make for 23% of the market capitalization of the S&P 500 index.

“Every time you have such a big concentration of high-performing stocks you run the risk of a bubble burst. People using the RSP as an underlying want to hedge that risk,” said Balcom.

Equal weights

The Invesco S&P 500 Equal Weight ETF on the other hand limits the weighting of each of its components to 0.258% at the exception of Exxon Mobil, which has a 0.44% weighting.

“This doesn’t mean there is no risk,” said Balcom.

One of them is an increased exposure to smaller companies in the S&P 500 index, according to Invesco’s website.

“These are not small cap companies obviously. But they are smaller companies, which may add some volatility. You’re reducing your concentration risk, but you still have some volatility,” he said.

Small buffer

Balcom’s view on the buffer was two-fold.

“I always like having a buffer on the downside. Without it, clients complain about losing the dividends and being capped on the upside. The buffer lets you outperform on the downside. That’s the tradeoff,” he said.

But the size of the buffer was too small, he said.

“10% on a two-year, that’s not a very large buffer. I can see that buffers are not easy to price on short-dated notes. But from the client’s standpoint, there’s not a lot of protection,” he said.

Bonds are better

Balcom said the risk-adjusted return hardly competed with bond yields

“I can get 5% on a Treasury, which is the risk-free rate. I don’t think I’m getting compensated enough with this note given the risk I’m taking,” he said.

One factor limiting pricing was the cost of the notes. The fee is 2%, according to the prospectus.

“Perhaps with a smaller fee you could have increased the upside or the buffer or both,” he said.

“In any event, this note doesn’t give me the incentive to take on risk compared to a bond.”

Mildly bullish

A financial adviser said investors in the notes were likely to have a range-bound view of the market.

“People have been so concerned about the big stocks. The S&P has really outdone the RSP, so this is a good way to avoid overexposure to Big Tech,” he said.

“It’s also a good choice for someone who wants large-cap exposure but who is primarily concerned about valuations.”

What caught this adviser’s attention was the trading range of the note.

“Obviously the 20% cap on a two-year means that you have moderate growth expectations. That’s why you want the leverage to boost your return,” he said.

Similarly, he found the 10% range of downside protection relatively “narrow.”

“This note is for someone who is neither bearish nor bullish,” he said.

Big deal

The top companies of the S&P 500 are those which have driven the rally so far, he noted.

“By giving up the large exposure to those big names, you may also give up more upside if the market continues to run. On the downside, your protection is limited. But by using the equal weighting, you’re smoothing out the tail risk,” he said.

For this adviser, the 2% fee may explain the large notional size of the deal.

“2% is a hefty fee clients have to overcome. By the same token, it’s probably how they get the product to be sold,” he said.

This adviser concluded that the notes would not be a good fit for conservative investors given the small buffer.

“It’s simply for someone who’s not very optimistic about the market and needs the leverage to juice up the return hoping to do better than if they had owned the market straight,” he said.

BofA Securities, Inc. is the agent.

The notes settled on Thursday.

The Cusip number is 06418H600.

© 2015 Prospect News.
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