High-coupon structured notes known as auto-callables are starting to make headway with U.S. retail investors. The structures have been popular in Asia and Europe, but have been viewed as too exotic for the vanilla appetite of U.S. investors. JPMorgan in New York has just closed two such structures, one referencing an emerging markets index fund and another linked to a trust that invests in gold. ABN AMRO is preparing an autocallable that references a basket of stocks. Other firms are also looking again at offering these notes on equity indices and single stocks.
JPMorgan officials declined comment on its offerings. A senior structurer at a U.S. firm said previous attempts to sell auto-callables to high-net-worth clients did not take off. There has been a sea change among investors in the last two years, however, and retail customers have started lapping up other structured notes such as reverse convertibles. "These are very much like a reverse convertible," he noted, adding it will appeal to investors looking for yield rather than growth.
Auto-callables tend to be short-dated with maturities around three years. The structure involves a series of call options that knock out if the underlying is above a certain strike on a pre-set valuation day, and pay the investor their capital and a high coupon. The valuation dates range from monthly to twice a year. If the note does not unwind on these dates it continues to the next and the coupon increases. The structures typically protect investors against a certain level of losses on the underlying.
The coupon size depends on the volatility of the underlying but it can be around 10% for an equity index. The cost of this coupon to the investor is the risk of capital loss if the underlying falls below a certain level. The investor also does not know when the structure will be called. This feature appeals to dealers because if it is called early they have the opportunity to sell another note as a replacement while the investor likes capital preservation plus a coupon.
