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Investors Forgo Structured-Note Protections in Bull Market Bet

Banks are selling the most U.S. structured notes that lack protection against losses in at least four years as less stock market volatility and lower interest rates limit the incentives that can be offered.

Of the 20 largest stock-linked offerings this year, $1.39 billion, or 87 percent, don’t offer a cushion against losses, according to data compiled by Bloomberg. That’s up from 63 percent of the $1.2 billion of biggest offerings during the year-earlier period and is the most since Bloomberg began collecting comprehensive data on the U.S. market in 2010.

Investors have to sacrifice some desirable structured-note features right now to capture potential gains, Michael Lynch, a vice president at Twenty-First Securities Corp. in New York, said in a telephone interview. Stock volatility in 2014 is about 25 percent below its long-term value and the Federal Reserve is holding its benchmark rate near zero, both of which affect the ability of banks to offer enticing terms on many securities.

“Any of these buffered structures out there are just not going to look as attractive,” said Lynch, whose company replicates structured-note strategies for investors.

The Fed is keeping the benchmark interest rate near zero for the sixth straight year, though it plans to move away from the unemployment threshold of 6.5 percent as a guide for when to lift borrowing costs, according to minutes of its January meeting. The Chicago Board Options Exchange Volatility Index, also known as the VIX, averaged 14.8 this year, below its average of 20.1 since 1990.

Bull Market

Investors in the notes lacking protection are betting stocks will keep climbing, after the Standard & Poor’s 500 Index gained 30 percent in 2013, the most in 15 years. They are benefiting from a bull market in which shocks are taking less time than average to dissipate.

Banks are also selling more large notes tied to benchmarks other than the S&P 500 Index, Bloomberg data show. Of the volume for the 20 biggest offerings, 22 percent, or $311.3 million, was linked to the U.S. stock index this year, down from 54 percent during the same period a year ago.

Banks are instead issuing more securities tied to the gains of multiple economic sectors or indexes of companies outside the U.S., Bloomberg data show. The amount of securities linked to the Euro Stoxx 50 Index more than doubled for the 20 biggest notes from last year, to $256.9 million.

“If the S&P is relatively less risky, now you have to start looking at indexes that assume some more volatility, which, from my standpoint, is self-defeating,” Justin Capetola, managing partner at Blue Bell Private Wealth Management LLC, said in a telephone interview from his office in Blue Bell, Pennsylvania.

Largest Offering

The S&P 500 has been the most popular stock index for structured-note investors since at least 2010, with $37.3 billion in sales linked to the benchmark, Bloomberg data show.

Credit Suisse Group AG sold $225.9 million of one-year securities, the year’s largest offering according to Bloomberg data, which don’t provide a buffer before investors suffer losses.

The securities, issued Feb. 7, lose value if 109 percent of the basket’s percentage gains aren’t greater than losses of the S&P 500 Index, with all capital at risk, according to a prospectus filed with the U.S. Securities and Exchange Commission. The basket is made up of the Financial Select Sector Index, the Industrial Select Sector Index and the Technology Select Sector Index.

Goldman Sachs Group Inc. issued a similar note seven days later in a $169.5 million deal, Bloomberg data show. JPMorgan Chase & Co. distributed both offerings.

Nicole Sharp, a spokeswoman for Credit Suisse, and Tiffany Galvin, of Goldman Sachs, declined to comment on the securities.

Banks create structured notes by packaging debt with derivatives to offer customized bets to retail investors while earning fees and raising money. Derivatives are contracts with values derived from stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.

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