Scotia’s $8.9 million trigger gears on index basket show unusually long tenor for equity bet

By Emma Trincal

New York, Dec. 22 – Bank of Nova Scotia’s $8.9 million of 0% trigger gears due Dec. 18, 2031 linked to an unequally weighted basket of equity indexes surprised market participants for its long maturity, something much more common with rates products than with equity-linked notes.

The basket includes the Euro Stoxx 50 index with a 40% weight, the Nikkei 225 index with a 25% weight, the FTSE 100 index with a 17.5% weight, the Swiss Market index with a 10% weight and the S&P/ASX 200 index with a 7.5% weight, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par of $10 plus 2.42 times any basket gain.

If the basket finishes flat or falls by up to 30%, the payout will be par.

Otherwise, investors will lose 1% for every 1% that the basket declines below the initial level.

Credit risk, dividends

The long tenor of the international basket was intriguing for Jeff Pietsch, founder of Capital Advisors 360.

“Ten years is unusual,” he said.

“International markets have offered such a discount compared to U.S. stocks and for a while. It seems like an interesting play to get exposure to overseas stocks over a long period of time.”

A long tenor however came with caveats.

Investors should keep in mind the counterparty risk, which increases with the term, he noted.

They should also find out the amount of dividends they have to give up over the long holding period.

“But on its face, given the extreme undervaluation of overseas assets relative to the U.S., given the 70% barrier and the 2.42x leverage with unlimited upside, this note can be a very interesting long-term play for an international exposure,” he said.

Reversion to the mean

Diversifying away from U.S. markets may be a timely move even if it did not pay off in the past.

“For years, people have expected Europe to have a big year. But they never have. Investors have clearly shown a strong preference for domestic stocks,” he said.

“At some point, this gap is going to close to some degree.”

One for five

The various basket components constituting a single underlying could be used by asset allocators, he said.

“It’s an international allocation in one security. You don’t have to buy five different ETFs and rebalance them short term. You can make that long-term bet in a levered way,” he said.

The leverage was more attractive with the notes than when applied to an ETF due to its asymmetrical nature. Noteholders in this trade but also in general only see their upside levered up, not the downside, he noted.

“That’s another big plus. Unlike a leveraged ETF, your downside is one-to-one. In fact, you even have some protection with the barrier.”

For investors with a long-term horizon, the notes offered some value, he concluded.

“You can achieve diversification long-term without having to make short-term allocations,” he said.

“It’s a way to avoid the pitfalls of the timing game.”

Unusually long

A financial adviser said the long tenor was surprising. While he liked the terms, he would opt for a shorter maturity.

“It sounds attractive based on the payoff. Obviously, the long term is going to allow you to get the 2.42x upside, no cap,” he said.

“How much leverage could you get on five years? If it’s 1.7x, would you rather take it?”

The answer to this question depended on individual preferences.

“But one thing is for sure: a 10-year leverage note is not something we see very often,” he said.

The term was in fact so uncommon for an equity product that he compared it to another type of investment.

“From my personal perspective, something that long almost looks like an insurance-type of product. It’s like an annuity more than a structured note,” he said.

Options pricing

Another issue with a 10-year tenor, he added, was options pricing.

“On 10-year, the options market is a lot thinner. If you take a less liquid market like the S&P/ASX for instance, you may end up with very thinly traded options,” he said.

This may reflect on the pricing.

“So, while the funding goes up over a longer term, the difference between a five- and a 10-year pricing may not be that substantial,” he said.

Passive investment

A long tenor can also be problematic when the underlying remains static without being rebalanced or actively managed over time.

“I like the terms. I like the idea of diversifying away from the U.S.

“But personally, I’d like to have more flexibility. Ten years is a long time.

“Who knows what investment trends will look like in 10 years? What about the basket components and the weightings? Who is to say that 10 years from now, Singapore is not an international financial center? Right now, Japan is a safe play. But in 10 years, especially in Asia, things could change rapidly. This basket for instance doesn’t include India, which is a fast-growing market.

“I would be reluctant to maintain the same static exposure over such a long period of time,” he said.

UBS Financial Services Inc. and Scotia Capital (USA) Inc. are the agents.

The notes settled on Monday.

The Cusip number is 06417T712.

The fee is 5%.

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