UBS’ trigger autocall contingent yield notes on Brent crude oil are high on risk spectrum

By Emma Trincal

New York, Sept. 26 – UBS AG, London Branch plans to price trigger autocallable contingent yield notes due Oct. 1, 2020 linked to the relevant nearby ICE-traded Brent crude oil futures contract, according to a 424B2 filing with the Securities and Exchange Commission.

Each quarter, the notes will pay a contingent coupon at the rate of 12% to 13% per year if the asset closes at or above the downside threshold level, 70% of the initial share price, on the observation date for that quarter.

The exact downside threshold level will be set at pricing.

The notes will be automatically called at par of $10 if the asset closes at or above the initial share price on any quarterly observation date.

If the notes are not called and the final asset price is greater than or equal to the downside threshold level, the payout at maturity will be par. Otherwise, investors will lose 1% for every 1% that the final asset level is less than the initial level.

Tactical bet

Commodities-linked notes issuance has been depressed this year as it has been over several years.

This asset class represents only 0.7% of all structured notes issuance for the year to date, which is $233 million in 48 deals.

However, oil recently has been in the forefront due to a recent oil shock induced by a drone attack in Saudi Arabia on Sept. 14.

“Everybody is jumping to create a note when there is more volatility,” said Steve Doucette, financial adviser at Proctor Financial.

“That’s when they can structure the derivatives. They provide a little bit more range and better terms,” he said.

“12% is a good return for a year. No question.

“But volatility works both ways because if you’re down below 70%, you’re in trouble.”

Drone shock

Volatility in the oil market erupted amid a record price spike, the biggest percentage point on record, following the attack. The price disruption, which eliminated about 5% of global oil output, sent Brent crude oil prices nearly 15% higher to $66.6 per barrel on the Monday following the weekend drone and missile strikes.

Since then, the market has stabilized. Brent oil futures closed at 62.79 on Thursday.

Investing in the notes would require a thorough analysis of oil as an asset, said Doucette.

“We tend to do broad indices, mostly in equity.

“I don’t really like dealing with a single asset class, or a single commodity,” he said.

MLPs in bear market

He pointed to a different investment highly correlated to energy – Master Limited Partnerships (MLP) – as an example of the damages of volatility.

“MLPs had a lot of advantages. Everybody was pitching it. It’s a non-correlated asset, yields are high, it’s tax-efficient... And they got slaughtered,” he said.

The most common MLP ETF – the Alerian MLP ETF – has lost more than half of its value over the past five years.

Risky asset class

Doucette said he was skeptical about commodities in general.

“They did tons of commodity indices. Everybody did it. It’s good for the portfolio they said. It’s an inflation hedge...”

Brent crude oil prices have declined by nearly 27% over the past five years with wild alternating up and down trends. Prices rallied in early 2016 until a year ago but reverted sharply during the fourth quarter’s global sell-off, sending prices down 25% in the past 12 months.

Another ground for uncertainty when it comes to oil is the future of energy consumption.

“You never know. You can’t really predict what the impact of renewable energy is going to be on oil. If some big oil company like Exxon decides to make a big push in renewables, it could have consequences on oil prices.”

Exxon has already “made an entry” in renewable energy, he added.

According to Exxon Mobil Corp.’s website the company since 2000 has invested $16.5 billion in research and development to provide innovative sources of energy.

Risk versus reward

Finally, Doucette was not comfortable with the way the structure itself mitigated risk as the potential for full downside exposure exists if the market is breached at maturity.

“You could try to capture a 12% coupon and hope not to burst the barrier on the downside,” he said.

“But you have a maximum 12% return on the upside with theoretically unlimited downside. I don’t think that’s a good risk/reward.

“You have to do your due diligence and decide if that’s enough return for the risk you’re taking. That’s a tough call.”

Entry point

Jeff Pietsch, head of capital markets at the Institute for Wealth Management, said the notes were designed for a specific type of investor and strategy.

“It’s for institutions that have a high conviction in short-term oil rise and whose specific goal is to generate income,” he said.

The current underlying price was not bad.

“It’s now trading in the midpoint of its five-year range and on the low-end of its annual range in spite of the recent spike.

“It has fallen off so much from the spike induced by the Saudi disruption it could actually be a good entry point for an institution engaged in an income play,” he said.

Factors at play

Oil prices can suddenly spike when global supply is disrupted as it happened last week, he explained.

On the other hand, supply growth and slowing demand could have the opposite effect.

“It appears that the market was able to deal with this sudden lack of supply. Prices have gone down since.”

Oil glut remains a factor that can put downward pressure on prices. Another one is demand.

“If the global economy happens to soften, the downside risk is very real,” he said.

Investors able to take the risk associated with the notes have to be sophisticated enough to analyze and hedge such risk, he said.

“This is an institutional play with significant downside risk. It’s definitely not designed for retail investors.”

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

The notes will settle on Monday.

The Cusip number is 90281E449.

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