UBS’ $525,000 trigger phoenix autocallables on iShares Silver offer inflation hedge, income

By Emma Trincal

New York, Oct. 19 – UBS AG, London Branch’s $525,000 of trigger phoenix autocallable optimization securities due Oct. 20, 2022 linked to the iShares Silver Trust offer a double-digit yield and a protection against inflation. But investors need to be aware of the reinvestment risk given current volatility in the market. In addition, the multiple industrial uses of silver make this precious metal more vulnerable to a recession than gold, advisers said.

If the ETF closes at or above the trigger price – 60% of the initial share price – on a bimonthly observation date, the issuer will pay a contingent coupon for that two months at the rate of 10.64%. Otherwise, no coupon will be paid that two months, according to a 424B2 filing with the Securities and Exchange Commission.

If the shares close at or above the initial price on a bimonthly observation date, the notes will be called at par plus the contingent coupon.

If the notes are not called and the shares finish at or above the trigger price, the payout at maturity will be par plus the contingent coupon. Otherwise, investors will be exposed to the share price decline from the initial price.

Negative view

The ETF offers exposure to the price of silver bullion, an alternative to buying physical silver.

Investors generally don’t buy silver for the sake of buying the precious metal, said Carl Kunhardt, wealth adviser at Quest Capital Management.

“Gold and silver are bearish assets. People who buy precious metals expect the market to go down,” he said.

The correlation between silver and stocks however is not always negative, he noted, at least not in a downturn.

Industrial metal

During the period from Feb. 24 to March 18, the iShares Silver Trust dropped nearly 39% and the S&P 500 index sank about 35% during that brutal and short bear market.

One factor is that correlations increase during market sell-offs. Another is because unlike gold, silver is an industrial metal used in multiple sectors of the economy, including for the manufacturing of semiconductors, medical devices and batteries.

“Silver and gold miners tend to move together although silver has more of an industrial use than gold,” said Jerry Verseput, president of Veripax Wealth Management.

This explains why silver may not hold up so well during a recession despite the safe-haven benefit of both precious metals.

Hedge, diversifier

Portfolio managers will have exposure to gold and silver to diversify their portfolio but also to hedge inflation.

The notes seemed particularly attractive as a protection against rising prices, which seem unavoidable when governments pump money into the economy, said Verseput.

“I tend to avoid precious metals simply because they are so speculative,” he noted.

“But it’s a good play from an inflation standpoint.

“If Biden wins and we get another $2.5 trillion stimulus, at some point we should expect a return of inflation.”

The U.S. government’s easing policy, pushing rates to record lows, carries the seeds of inflation and goes hand in hand with a weakening of the U.S. dollar as capital flows to other currencies, he explained. The fiscal stimulus has increased the debt burden and is associated with money-printing, which also weakens the value of the dollar.

Precious metals tend to benefit from the depreciation of the dollar.

Structure

The notes also offer an attractive structure, he said.

“I like this note a lot.

“Being able to get almost a 10% cash flow is great.

“There’s plenty of barrier,” he added.

While the ETF share price dropped significantly in March, it is trading 17.5% off its August 52-week peak.

“I think your chances of collecting the coupon and getting called are pretty high,” he said.

A call two months after the trade date would not be a concern for this adviser.

“I always look at these as an opportunity,” he said.

“If it gets called you get two months’ worth of 10%. You make 2% with almost no risk.

“I wouldn’t rely on this for somebody who needed income because of the reinvestment risk.

“I would just use it from a total return standpoint.”

Call risk

Other advisers however have little tolerance for reinvestment risk.

“I’m just wondering why you would go through the hassle of buying this,” said Quest’s Kunhardt.

“Purchasing structured notes is not exactly easy. It’s a little bit more involved than buying a mutual fund or an ETF.

“Each time you’re talking about silver or gold, you’re talking about volatility. This is an investment based on your view on volatility. If volatility spikes, the value of silver will go up.

“We’re 15 days from the Elections. We won’t know who won by then. Everybody is praying we will know the results before Jan. 20.”

This situation will cause volatility to rise in the few weeks, he predicted.

“This note is going to be called right away. I don’t think we’ll get to pass December.

“It’s a lot of trouble for a two-month investment.”

Too short

The “trouble” was not just the risk of an early call making the reinvestment of the proceeds at a comparable risk-adjusted return perhaps a difficult goal to achieve.

Kunhardt’s main objection was the short-term view.

I’m not making investment decision for the next week or the next couple of months.

“As a planner, I’m looking at three, five, seven years, multiple years. We’re really not playing short-term.

“If this note didn’t have this autocall feature, I would have liked it much more.”

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

The notes priced on Friday and will settle on Tuesday.

The Cusip number is 90282B832.

The fee is 1%.

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