Return differential between S&P, Russell seen as key risk with JPMorgan’s $2.05 million notes

By Emma Trincal

New York, Nov. 21 – JPMorgan Chase Financial Co. LLC priced $2.05 million of 0% uncapped dual directional buffered return enhanced notes due Nov. 20, 2026 linked to the S&P 500 index and the Russell 2000 index, according to a 424B2 filing with the Securities and Exchange Commission.

If the worst performing index gains, the payout at maturity will be par plus 123% of that index’s return.

The payout will be par plus the absolute value of the worst performing index return if the worst performing index declines by no more than 20%.

Otherwise, investors will lose 1% for every 1% that the worst performing index declines beyond 20%.

“The credit of the issuing bank is very good. We don’t have any problem with that. But I don’t love the notes for several reasons,” said Steven Foldes, wealth manager and founder of Evensky & Katz / Foldes Financial Wealth Management.

Laggard

His main “reason” was the choice of the underliers.

“I don’t like the worst-of between the S&P and the Russell. Notwithstanding the fact that the correlation between the two is very high, which helps in relation to their direction, they show a huge performance differential,” he said.

Such a gap guaranteed the exposure to an index whose return would be significantly lower than the other, he said.

“That to us is a non-starter,” he said.

The S&P 500 index and the Russell 2000 have gained respectively 18% and 1.5% for the year to date, he noted.

“That’s a big difference, and while they can move in the same direction, you certainly don’t want the exposure to the laggard,” he said.

Rebuilding the note

The tenor was not perfect but still acceptable.

“Three years is a little bit longer than we like for a note, but we can live with it,” he said.

The downside structure should be revisited. Foldes said he had no need for the buffer and absolute return.

“To finish negative in three years as we’re currently still down 6% from the all-time high of January 2022 is very unlikely,” he said.

Foldes would want to improve two components of the structure. First increasing the leverage multiple and second, limiting the exposure to a single index.

“I’d rather get rid of the buffer, do away with the absolute return and get more leverage,” he said.

“The uncapped leverage is great. But we don’t want our performance to be hurt by the worst-of. So, I would also want a note tied to a single index.”

Multiple benefits

A financial adviser expressed similar concerns.

“The worst-of is the good news and the bad news,” he said.

“Without it, there is no way in the world you could get uncapped leverage on a three-year bullet with a buffer plus the absolute return. Absolutely no way.

“The worst-of gives you multiple benefits. But you’re taking a huge amount of risk as well, especially with those two indices.”

He too stressed the return differential between the large and small cap benchmarks.

Over the past three years, the annualized return of the S&P was 10.2% versus 3.8% for the Russell, he noted.

“There is an enormous gap in performance between the two,” he added.

“This is not a 99.9% correlation. If we put clients in those worst-of, we have to find a way of measuring that risk.

“In this particular case, the differential is too big to make me comfortable.”

The terms, however, especially the buffer, were exceptionally attractive, he noted.

Efficient buffer

“You get a pretty efficient protection,” he said.

This adviser ran some back-testing analysis going back to 1987 in order to assess the frequency of buffer breaches.

Over three-year rolling periods, the S&P 500 index was negative 15.2% of the time. Within that bucket, the index remained within the buffer zone 8.8% of the time.

“That’s roughly a 58% chance of being fully protected by the buffer, which is quite good. In this case it’s even better with the absolute return,” he said.

This left a 6.4% probability of a drop beyond the buffer strike. But even in such scenario, investors would still outperform, he said.

“Regardless of the decline, the buffer will let you beat the market all the time,” he said.

For the Russell 2000, the test revealed a 12.7% frequency for a negative return, which included a 7.3% frequency for a decline within the buffered area. Overall, investors had a probability of approximately 57% of outperforming twice via the protection and the absolute return. Again, a decline beyond 20% would still allow investors to outperform the index.

Beating the market

“You’re going to outperform on the downside thanks to the buffer and the absolute return and you’re going to outperform on the upside because of the leveraged exposure,” he said.

As always, investors will not earn any dividends. Both indexes have a dividend yield of 1.7%.

“There’s just a tiny window of underperformance due to the loss of dividends. A very tiny one,” he said.

The underperformance was indeed “tiny” due to two factors – the relatively short duration and reasonably low dividend yields, he said.

“You can’t write a note better than this. If you hold it to maturity, you’re going to beat the market.

“The worst-of is the only problem. You’re not going to beat both markets. That’s the only risk you’re taking.

“But it’s not a small one,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes will settle on Wednesday.

The Cusip number is 48134RDY1.

The fee is 0%.

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