Advisers compare UBS, TD notes on EEM offering different leverage, buffer options

By Emma Trincal

New York, Feb. 4 – Two issuers recently priced leveraged buffered notes on emerging markets, a rare opportunity to get exposure to international equity with the market flooded with U.S. underliers, according to two buysiders who compared the two issues.

In each case, the notes have a two-year maturity and are linked to the same exchange-traded fund. The structures featured comparable caps of 20% and 21%, respectively. The difference lied in the level of buffered protection and the amount of upside leverage with one of the notes slightly more defensive than the other.

UBS AG, London Branch priced $1.32 million of 0% capped buffer gears due Feb. 6, 2023 linked to the iShares MSCI Emerging Markets exchange-traded fund, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 1.25 times the ETF return, capped at par plus 20%.

There is a 15% buffer on the downside.

Two trading sessions earlier, Toronto-Dominion Bank priced $17.39 million of 0% capped Leveraged Index Return Notes due Jan. 27, 2023 on the fund.

If the index return is positive, the payout at maturity will be par of $10 plus 200% of the index return, capped at 21.06%. Investors will receive par if the index declines by 10% or less and will lose 1% for each 1% that the index declines beyond 10%.

Bullish call

“They both have a buffer so you’re going to outperform on the downside. I like that,” said Steve Doucette, financial adviser at Proctor Financial.

“Now whether it’s 10% or 15% buffer depends on whether you’re bullish or bearish.”

The term of the notes will certainly help make that determination.

“Two years is a tough time. We still don’t know where this market is heading,” he said.

“Looking at the recent volatility we could see a 10% or 20% pullback for a few months and be off to the races again.”

Attack on the cap

Doucette, who is relatively bullish on the asset class, was more focused on the cap than on the buffer size.

“I’m comfortable with both buffers, the 10% and the 15%, because if the market is down, I will outperform either way,” he said,

“The real question is: how bullish are you?

“2x is a lot of leverage.

“I would give up some leverage to get rid of the cap. If you’re bullish, you don’t want to be capped out.”

But the lowering of the leverage may not be sufficient to remove the cap, he said.

“If giving up some of the leverage is not enough to get rid of the cap, I would go for the smaller buffer at 10%, whatever needs to be done to push up that cap or eliminate it,” he said.

Finding value

Doucette said his reasoning would be different if the underlying was the S&P 500 index or the Dow Jones industrial average or any large U.S. stock index. Emerging markets have a high likelihood to outperform the U.S. market because they are not as overvalued, he said.

“I hear more and more analysts saying that emerging markets is the place to go for better returns going forward. It has a lot more upside potential than domestic equity,” he said.

“DFA, GMO are now pushing allocations to emerging markets in excess of 10%.”

He was referring to Dimensional Fund Advisors LP (DFA) and Global investment manager Grantham, Mayo, Van Otterloo & Co. LLC (GMO), two large investment managers whose research on portfolio allocation is popular among institutional investors.

“These are pretty smart minds focused on valuations,” he said.

In its January outlook, Jeremy Grantham, co-founder and chief investment strategist of GMO, warned that the “long, long bull market since 2009 [...] is now one of the great bubbles of financial history, right along with the South Sea bubble, 1929, and 2000.” He pointed to the fact that emerging markets are now trading at 50-year lows relative to the U.S. equity markets.

“If you’re bullish on emerging markets, you have to get rid of the cap,” said Doucette.

Cautiously opportunistic

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he was relatively bullish on emerging markets. But risk mitigation is his priority especially in today’s environment.

“I do like the asset class. The valuations look good. Commodities have been struggling and are starting to rebound. Commodities-rich emerging markets will benefit from that,” he said.

“However, I’m more concerned about protecting the downside than enhancing the return.

“Since the caps are quite similar, I would lean toward the note with the 15% buffer.

“Because of the volatility in the market and where we are in the growth cycle, having a little bit more of a buffer is my preference even if requires cutting some of the leverage,” he said.

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

The notes (Cusip: 90276BPP2) priced on Feb. 1 and settled on Thursday.

The fee is 0.5%.

BofA Securities, Inc. is the agent for the Toronto-Dominion Bank offering.

The notes (Cusip: 891160269) priced on Jan. 28 and settled on Thursday.

The fee is 2%.

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