UBS’ two $5 million deals with five-times leverage are designed for mild bulls seeking alpha

By Emma Trincal

New York, June 18 – UBS sold two nearly identical deals last week, each for $5 million and featuring five-times leverage on the upside and a relatively high cap, sources said. Each offering was brought to market by a different issuer and was linked to a separate index.

Barclays Bank plc’s $5 million of 0% return optimization securities due June 17, 2019 linked to the Euro Stoxx 50 index have a 94% cap on the upside, and investors are exposed to any losses, according to a 424B2 filing with the Securities and Exchange Commission.

Separately, Morgan Stanley issued $5 million of 0% return optimization securities due June 17, 2019 linked to the FTSE MIB index, according to a 424B2 filing with the SEC.

The FTSE MIB (Milano Italia Borsa) is the benchmark stock market index for the Borsa Italiana, the Italian national stock exchange.

The payout and risk exposure at maturity are the same except for the cap, which is 82%.

Range-bound view

“These highly levered notes used to be more of a retail type of product, but we’re seeing this structure moving into the institutional space as well,” a market participant said.

As the markets have reached new highs, an increasing number of investors are expecting range-bound returns, he explained.

“That’s the basic concept behind this structure. You have a lot of leverage on the upside with a pretty good cap, which will enhance your returns quite a bit if the market trades sideways,” he said.

“The benefit of the structure is this asymmetrical payout: five-to-one on the upside and one-to-one on the downside.

“If the market doesn’t rally too much, you’ve outperformed the benchmark.

“If it sells out, you don’t do any worse than the benchmark. You’re not giving anything up on the downside. If you already have exposure to the benchmark in your portfolio, it’s a way to enhance the return while your performance is in line with the downside.”

Investors in these products, while still bullish, would have to hold a moderately bullish outlook, he said.

“If you think the market is a bit toppy and that it’s going to trade in a range, it’s a good way to generate alpha,” he said.

Andrew Valentine Pool, main trader at Regatta Research & Money Management, said that the high leverage factor over a longer-than-average tenor offers enough value to offset the lack of downside protection. He also said that he likes the two respective underlying indexes.

Attractive underliers

“I like the deals in part because I’m bullish on both indexes. We would actually buy both notes and not just one,” he said.

“If we were to buy those two, we would probably allocate 4% of our new purchases bucket to the Euro Stoxx and 2% to the Italy deal. We think Italy is one of the strongest countries in Europe, but we would combine it with the Euro Stoxx to spread the risk,” he said.

Usually highly leveraged deals tend to restrict the upside potential with lower caps, but such is not the case with these products, he noted.

“We are bullish, but we still like the leverage, as the caps are relatively high. With five-times leverage, even if there is no downside protection, for a small piece of our portfolio, we would do it,” he said.

Cost-effective leverage

The leverage factor of five is the component of the structure that offers the most value, he said.

“Five times is pretty high. Is there a five times ETF on Italy that I don’t know of?” he said, implying a negative answer.

“I’d have to price the options and see how much it would cost us to do it ourselves, but I assume that when a big issuer is doing something like that their volume creates a better pricing. For them to issue it is probably better than for me to buy it on my own.

“If I did it, I would probably not bring more than $1 million. They have the infrastructure to buy the options. Everything is in place. That’s what they do all the time structuring those deals, hedging the risk.

“To get that type of leverage, five times up on a five-year ... that much leverage going out that long, it gets kind of pricy. I don’t think we could do it, at least not as cost-efficiently.”

Risk-adjusted return

Having full downside exposure is the least appealing part of the structure. But Pool said the risk is acceptable as part of a fair risk-reward trade-off given the high potential return.

“This is an example where I can live with no downside protection because I’m getting something really valuable on the upside. Getting five-times leverage is pretty healthy.

“We tend to be cautious about longer-dated notes that have no buffers simply because it’s hard to get out of a structured product. But this case would be an exception as the upside participation is very attractive,” he said.

Barclays was the agent for the first deal (Cusip: 06742W661), and Morgan Stanley & Co. LLC was the agent for the second one (Cusip: 61761S489). UBS Financial Services Inc. was the dealer for both deals.

Both deals priced on Friday.

The fee for each deal was 2.5%.

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