UBS’ trigger gears tied to Bloomberg Commodity offer long-term commodity play

By Emma Trincal

New York, Nov. 21 – UBS AG, London Branch plans to price 0% trigger gears due Nov. 27, 2024 linked to the Bloomberg Commodity Index 3 Month Forward, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par of $10 plus 1.4 to 1.5 times any index gain.

Investors will receive par if the index falls by up to 30% and will be fully exposed to any losses if the index finishes below its 70% downside threshold.

UBS Investment Bank and UBS Financial Services Inc. are the agents.

The notes will price on Nov. 28.

The Cusip number is 90280X737.

Commodities-linked notes have nearly vanished from the U.S. market in the past few years. Only 30 such deals have been priced so far this year out of 11,455 in total. This asset class showed a $289 million volume this year, which was less than 1% of the total market through Nov. 17, according to data compiled by Prospect News.

Part of the problem, according to sources, is the complexity associated with “rolling” the futures contracts, which are the components of commodity indexes.

Futures curve

“The rolling and contango issues...to get your arms around that is a real challenge,” said Steven Foldes, vice-chairman at Evensky & Katz / Foldes Financial Wealth Management. Commodities as an asset class only represent a “small piece” of his overall portfolio despite the benefit their low correlation to equity can provide.

“Futures contracts expire, and having to roll that into new contracts and depending on how the curve is sloping at that point, you could get hit,” he said.

The underlying index follows the same methodology as the Bloomberg Commodity index, which was known as the Dow Jones-UBS Commodity index, according to the prospectus.

Both indexes are composed of futures contracts on physical commodities that need to be rolled as they expire.

The main difference is that the Bloomberg Commodity Index 3 Month Forward tracks longer-dated commodity futures contract, according to the prospectus.

Contango is when prices of contracts are higher in the distant delivery months than in the nearer delivery months. Such scenario has a cost referred to negative roll yield, which can decrease the value of the index.

By looking further on the curve, the Bloomberg Commodity Index 3 Month Forward was designed to reduce the negative effect of contango.

“They just roll the third month instead of buying the nearby contract. Usually it tends to be cheaper but not always,” said a commodities portfolio manager.

Problematic points

For an adviser the nuances regarding the shape of the futures curve can be time-consuming.

“It takes a different level of sophistication to understand these technicalities,” said Foldes.

“And while it’s always good to diversify your portfolio, you get the treachery of dealing with futures and forwards.”

Terms

Looking at the structured notes themselves, Foldes objected to the long maturity.

“Seven years on a note – this is way too long for us,” he said.

“Obviously we like the idea of leverage, we like having uncapped exposure.

“Having a barrier is always nice although we prefer a buffer because if you breach the barrier, you’re responsible for the entire loss as opposed to incremental losses with a buffer.

“But seven years is a non-starter for us.”

Another objection, somewhat related to the tenor, was the 3.5% fee.

“The cost here is a little bit problematic. I know that it’s 50 basis points per annum, which does not seem much except when you have to pay that over a long period of time.

“We would expect half of it.”

Long-term bet

Commodities have improved in the second half of this year. The underlying index has gained 8.25% in the past five months.

“A seven-year bet on commodities is a little bit difficult to take,” said the commodities portfolio manager.

“A 30% barrier is not that significant when you’re dealing with this asset class.

“On the other hand, commodities are still cheap and did pretty well this year.

“You really have two schools. Some people are saying that this rally is overdone. Others anticipate a resurgence of inflation, which could give more upside potential to commodities.

“This is a retail-driven investment. Retail investors are overweighing equity. This could make sense if they want to diversify their portfolio.”

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