JPMorgan links to long-short commodity index, offers access to trading strategy, adviser says

By Kenneth Lim

Boston, Aug. 3 - A planned series of notes linked to a long-short commodity index could be attractive to followers of momentum investing theory and those who want exposure to the asset class, an investment adviser said.

JPMorgan Chase & Co. plans to price zero-coupon return notes due Aug. 8, 2011 linked to the JPMorgan Commodity Investable Global Asset Rotator 9 Conditional Long-Short index.

The index seeks to implement a momentum-based algorithmic strategy for commodity allocations. It reflects the value of a synthetic long or short portfolio of commodity indexes, depending on the indexes' recent historical performance and consistency. An annual adjustment factor of 0.96% is also taken out from the index value.

The payout at maturity will be par plus the index return over a strike value, which will be set at pricing. Investors are fully exposed to losses beyond the strike value.

Buying momentum

The key feature that is being offered through the notes is the momentum investing strategy rather than the commodity market, the adviser said. That is because buyers are unlikely to have a particular view of commodities, the adviser said.

"I think what you're buying is a convenient way to apply a momentum trading strategy," the adviser said. "It's a long-short index, so in theory you're seeking absolute returns, and it's the underlying algorithm rather than the asset class that makes the difference here. Maybe the investor wants to have some exposure to commodities, but it's not because they think commodities are going to do well or they're going to drop further."

The structured product is an easier way to implement the underlying strategy for investors, compared with doing it on their own. It is also slightly cheaper than many funds, the adviser noted.

"They do take out a small fee from the index, but that's less than what you would normally pay for an alpha fund," the adviser said. "If you don't think that you're getting more for your money by paying a fund manager, algorithms can be an alternative."

The product is also highly risky because investors have no protection on the downside, but that might not be much of a deterrent for investors who are already prepared to invest in a fund.

"It's very similar to buying a fund or the index," the adviser said. "Economically, your exposure to the index on the upside and downside is one-to-one, although you do have counterparty risk."

Algorithmic solutions

Algorithmic solutions can be useful for investors who want to boost returns, the adviser said.

"Innovative indexes are basically a way to try to make a particular strategy easily accessible to investors," the adviser said. "I think they serve a useful purpose. You can allocate part of your portfolio to more hedge fund-like investments to potentially get a better return, especially if you look at absolute return strategies that have the potential to smooth out your returns in different markets."

But the adviser added that structured products and algorithmic indexes are not the only options available, and they are not necessarily superior to managed funds or exchange-traded funds.

"The indexing people will tell you their algorithms are the best, but the reality is it's not always the case," the advisers said. "Algorithms can only follow rules, fund managers in theory can follow those rules and exploit exceptions when they recognize it. So like every other investment, investors have to think about what their objectives are, do their research, consider the costs, risks and potential rewards."

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