Jovian notes bet against banks

While complaining about the big banks has become almost a bit of a national pastime for some, underestimating their ability to turn a profit is not. Nevertheless, Jovian Capital and its subsidiary, JovFunds, say that with rising interest rates, the time is right to bet against the banks with a new principal protected note they launched on Monday.

The Gibraltar Bear Canadian Banks Deposit Notes, Series 1, which will be issued by Société Générale, are principal protected notes designed to pay out in the event that its basket of bank stocks decreases in value.

The underlying portfolio is composed of equally weighted common shares of Canada’s “Big Six” banks: Bank of Montreal, Canadian Imperial Bank of Commerce, Royal Bank of Canada, Toronto-Dominion Bank, the Bank of Nova Scotia and National Bank of Canada.

The notes have a three-and-a-half-year maturity and in the event that the basket decreases in value by maturity, JovFunds will pay the holders a positive return equal to the absolute value of the negative return. In the event that the basket breaks even or increases by maturity, investors will get back their principal investment.

JovFunds’ managing partner, Raj Lala, says that his company is not marketing the notes to investors keen to gamble on the banks’ stumbling over the short term. Rather, Lala says that since the notes are principal protected, they can function as a low-risk counterbalance to a portfolio heavily weighted in bank shares.

“By pure portfolio composition perspective, Canadian investors are overexposed to the banks,” he says. “You have a lot of advisors and their clients that have a massive amount of exposure to the banks, either through single positions or through managed products such as mutual funds.”

Lala says over the long term, banks have consistently performed, and most investors would be wise to hold on to their bank shares, but in the short term, there can be moderate volatility. So hedging against the banks could keep portfolio performance steady, particularly during a period of rising interest rates that have historically cut into bank profits, he adds.

During these periods, investors could increase their short-term performance by selling off bank stock in the short term, but this triggers a capital gains tax, and the investor risks missing out on the more frequent performance upswings of the bank, Lala says. He believes the Jovian notes can serve this void as a short-term offset to bank performance.

Jovian is not just targeting the clients of advisors but the advisors themselves, Lala says, “especially the brokers at the bank-owned dealers because they’re given so much stock via options or direct stock purchases from their dealership. I would bet 60 to 70% of [a bank advisor’s] portfolio is in Canadian bank stock.”

The Jovian notes are available for purchase from June 4, 2007, to July 27, 2007. They are RRSP eligible and have a minimum investment requirement of $5,000.

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com