UBS’s trigger gears tied to S&P 500 index show ‘decent’ cap for low-growth scenario

By Emma Trincal

New York, Nov. 3 – UBS AG, London Branch’s 0% capped trigger gears due Nov. 29, 2019 linked to the S&P 500 index provide investors with an opportunity to outperform the market in a muted performance environment, sources said.

If the index return is greater than zero, the payout at maturity will be par of $10 plus two times the index return, subject to a maximum return that is expected to be 30% to 34% and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index declines by 25% or less and be fully exposed to the index’s decline from its initial level if it declines by more than 25%.

Next race

Elliot Noma, founder of Garrett Asset Management, said the notes were designed for investors expecting a “flat market environment” for the next three years.

“Whoever wins the elections next week, some analysts predict that it will be a one-term presidency because of the lack of enthusiasm for any of the candidates. The notes would mature at a time when the new race will have already started. That’s a potential headwind,” he said.

Slow growth

Without being bearish on the U.S. markets, Noma said he could envision a scenario in which the S&P 500 performance could be relatively flat over the next upcoming years. One reason was the 7.5-year long bull market cycle, which at some point will come to an end.

The Federal Reserve’s future monetary policy was another and important factor.

Fed’s ammo

“The Fed is under pressure to raise rates. They have to do it because right now they don’t have the ammunition to stimulate the economy if we have a short-term shock. If the tools are not available to them, they don’t have insurance against the next recession.”

Higher interest rates would have a bearish impact on bonds and would weigh on equity markets as well, he said.

“We don’t have those headwinds yet, but if the economy starts to overheat, the Fed will have to put the brakes on a little bit,” he said.

“That sends a mixed signal. Investors would welcome a stronger economy, but the market would be under more pressure,” he said.

The 30% to 34% cap range represents a range between 9.15% and 10.25% in maximum return on an annualized compounded basis. The S&P 500 index would only have to rise between 4.75% and 5.35% for investors to reach the cap.

“It’s a pretty good level, and I don’t think investors would run into the risk of being capped,” he said.

“For a customer who doesn’t expect a very bullish market, it’s a reasonable note.”

Cap eyed

Steve Doucette, financial adviser with Proctor Financial, said the notes offered an attractive payout.

“The cap is decent. Getting two-times up and roughly 10% return is not bad,” he said.

Perhaps the slow-growth scenario, on which the structure is based, may be too pessimistic. Doucette saw potential for the market be provide enough return, at least more than the 5% per year required to hit the cap. At the same time, volatility should not be ruled out, which led him to focus on the issue of controlling risk on the downside.

“We’ve been hearing this mantra about the market... the new normal is not going to be 10% return but something much less. But we’ve been hearing that for five years and this market is still up. It has slowed down this year. But 11 months don’t determine the real direction of the market,” he said.

Bullish, yet cautious

The notes are designed for moderately bullish investors. Being more bullish in his outlook, Doucette said he might want to reduce the leverage in exchange for an improved protection.

“If the market is up, you may be able to capture the cap with a little bit less leverage than two times. I may reduce it and change the barrier into a buffer,” he said.

While the next recession and market correction may be delayed “a little while” because “all the economic indicators are reasonable right now,” it does not mean things may not change.

While there is no reason for the market to go down imminently, “three years out we could be down more than 25%,” he said.

For this reason, Doucette would prefer to convert the barrier into a buffer, keep the cap and reduce the leverage.

“I don’t know how much buffer it would translate into... if it’s 15% or 10%. But we would strive to get the 10% return on the cap. In exchange we would be willing to reduce the leverage.”

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

The notes are expected to price Nov. 28.

The Cusip number is 90275Y716.

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