UBS’s $12.11 million trigger autocalls on ETF basket designed for value, range-bound play

By Emma Trincal

New York, June 14 – UBS AG, London Branch’s $12.11 million of 0% trigger autocallable notes due June 14, 2023, linked to an equally weighted basket of exchange-traded funds aims to generate income on the recovery stocks that have rallied over the past few months in a rotation from growth to value.

The view however is only moderately bullish as gains are capped at a single-digit return.

The basket consists of the Financial Select Sector SPDR fund with a 25% weight, the Consumer Discretionary Select Sector SPDR fund with a 25% weight, the Energy Select Sector SPDR fund with a 25% weight and the Industrial Select Sector SPDR fund with a 25% weight, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus a call return of 8% per year if the basket return is at or above its initial price on any quarterly observation date after six months. Previously unpaid call returns will also be paid.

If the notes are not called and the basket price finishes at or above the downside threshold, 75% of the initial price, the payout at maturity will be par. Otherwise, investors will be exposed to the price decline from the initial price.

Range-bound

“It seems interesting if you think the market is going to be relatively flat in these areas,” said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

“The trend has been towards value and away from growth. For people who continue to be very bullish on value stocks, this would not be attractive.

“We’ve seen a recent push toward growth so it’s possible that value-oriented strategies may not perform as well looking forward.”

Chisholm examined the downside protection in relation to the return.

Risk-adjusted return

“As long as those sectors are not going to sell off by 25% and stay relatively flat, this is a reasonable investment.

“You’re giving up some upside by capping your return at 8%.

“Personally, I think you’re giving up more upside than you have to. Your potential is limited to 2% per quarter.”

Lower yields are unfortunately a worsening market trend despite a bond sell-off in March, which was due to inflationary anticipations, he said.

Yield search

“There is a real push for yield,” he said.

“Long-term rates were up a couple of months ago on inflation fears. But they have come down. This is not helping financials, but it has helped growth stock to come back in favor.”

The outcome for growth stocks may be positive again as rates have settled.

“I don’t think rates are going to go up. Inflation is a transitory thing due to supply chains being damaged and pent-up demand.”

But the basket of value stocks does not need to rally.

“As long as you’re not negative, you can collect your 8% a year. It’s a typical range-bound play.”

Moving parts

Jerrod Dawson, director of investment research at Quest Capital Management, was undecided about the deal.

“The more complex, the less I like it. There are too many moving parts. That’s a drawback,” he said.

He brought up the valuation issue.

“The basket is built around a theme that has been working recently: value, cyclical-oriented stocks.

“It could continue to work on a momentum. The most powerful force short term is momentum.

“But those sectors are also richly valued, which is always a concern.”

High performances

The Energy Select Sector SPDR ETF and the Financial Select Sector SPDR ETF are the two top performers in this ETF series for the year with gains of 39.11% and 29.4%, respectively.

State Street Global Advisors manages 11 Select Sector SPDR funds. The Industrial Select Sector placed fifth has returned 18.93% this year. The Consumer Discretionary is up 7.6% year to date.

Volatility, tradeoff

“You give up the upside and get something else in exchange. The most obvious benefit is the 75% barrier, which is pretty decent,” he said.

“The 8% return is reasonable based on historical averages. But nothing strikes me as exciting.”

While the barrier is acceptable, some sectors like energy are “very volatile,” he noted. The diversification offered by the basket allocating to four ETFs in equal weights presumably was advantageous, especially when compared to worst-of payouts. But for Dawson, it was not enough.

“We typically need more diversification. We use broad indices or a combination of indices,” he said.

The tradeoff was not clear to this analyst.

“We often buy accelerated return notes. We like the risk-return better. With this one, you’re capping your upside to 8% with unlimited downside,” he said.

“There is no free lunch, I understand that. But the tradeoff in any investment should be more apparent. The positive should outweigh the negative.”

Liquidity

Despite the call feature and the short tenor, Dawson raised the issue of liquidity.

“You’re still locking yourself in for two years. You have to assume you will be holding the notes to maturity,” he said.

“It doesn’t strike me as something we would really do. If I were considering doing it, I would be sitting on the fence, not sure what decision to make. The complexity of it gives me pause.”

Dawson said he saw the product as an income play with “equity-type volatility.”

“I suppose this was done for someone interested in value and cyclical stocks or for someone chasing returns. But these sectors are already over-extended. That would be my main concern,” he said.

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

The notes settled on Monday.

The Cusip number is 90278Y820.

The fee is 1.5%.

© 2015 Prospect News.
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