BMO’s autocallable contingent coupons on indexes, gold ETF offer high coupon, deep barriers

By Emma Trincal

New York, Jan. 21 – Bank of Montreal’s autocallable barrier notes with contingent coupons due April 26, 2022 linked to the Nasdaq-100 index, the Russell 2000 index and the VanEck Vectors Gold Miners exchange-traded fund introduce diversity in the mix of underliers by using a volatile fund along with the common indexes, which provides better pricing, an adviser said.

Every month, the notes will pay a coupon equal to 14% per year if each underlying’s closing level is at least 65% of the initial level on the observation date for that period, according to an FWP filing with the Securities and Exchange Commission.

The notes will be automatically redeemed at par plus the contingent coupon if each underlying closes above its initial level on any quarterly observation date after six months.

If the notes are not called, the payout at maturity will be par unless the final level of any underlying is less than 60% of the initial level, in which case investors will lose 1% for each 1% decline from the initial level of the least performing underlying.

Terms

Steve Doucette, financial adviser at Proctor Financial, was impressed by the terms.

“We know the market indices are volatile. Gold, gold miners are very volatile,” he said.

“But 14% is a pretty impressive coupon. For 15 months, you can collect almost half of it since there’s no call in the first six months.

“Not only that... you have a 35% barrier for the coupon and 40% on the downside protection. That’s very decent.”

The implied volatility for the VanEck Vectors Gold Miners ETF is 35.58%. The Russell 2000 index has a volatility of 30.10% and the Nasdaq-100 has a volatility of 27.4%.

The case for gold

“The gold one is the most volatile of the three. At the same time, everybody is talking about inflation coming back with all the debt we’ll be carrying.

“If all that chatter turns out to be the right prediction, it’s bullish for gold given that gold is a hedge against inflation.”

Another positive about the ETF was its current valuation.

The fund closed at $35.71 on Thursday, much higher than its $16.08 low of March. Yet the fund is trading 22% lower than its August high.

“You would have to go back to the levels of March last year to be down 35%. That’s a big drawdown,” he said.

Volatility, valuations

Doucette said the insertion of a relatively volatile ETF alongside the two indexes instead of the usual trio of U.S. indexes currently found in worst-of deals added value.

“It’s amazing how the volatility of one can expand the barrier of this note and gives you a much higher coupon.

“If I was concerned about busting the barrier, I would look at the indices, not so much the gold miners.

“The Nasdaq just posted a new high today. The Russell keeps hitting new peaks as well. It’s probably one of these two that’s most likely to come down,” he said.

The Russell 2000 index posted an all-time high on Monday at 2,173.72.

“Still, it doesn’t mean you’re necessarily going to see a 35% drop. You’re still collecting the coupon, which gives you more of a hedge along the way,” he said.

High-yield alternative

Matt Medeiros, president and chief executive of the Institute for Wealth Management, was more cautious.

“This deal is probably good for a specific situation. It’s obviously a way to get some high yield. But you’re trying to enhance the coupon by introducing pretty risky assets,” he said.

“Gold miners for instance are even more unpredictable than gold prices. The Nasdaq has been trending higher and higher. It is overstretched.

The tech-heavy benchmark has climbed 44% in the past 12 months. It has nearly doubled since its bottom in March.

“The Russell is a little bit more attractive from a fundamentals standpoint. But it’s still overpriced. Both indices are overvalued,” he said.

Medeiros said the notes would not be useful for an asset allocator.

“It would be a challenge to use something like this in a portfolio. It’s strictly income.

“I guess it’s designed as an alternative to a high-yield-type portfolio.

Risky bet

“But unlike fixed-income investments you have a high degree of uncertainty here, which limits your chances of securing a consistent cash flow.

“You can be called out in six months. There’s a high probability of being called on the first call.

“Everything is contingent. You’re not sure if or when you’ll get called. You don’t know if you’ll get your coupon and how much of it at the end. You’re not guaranteed your principal back at maturity.

“It’s a risky way to chase yield,” he said.

BMO Capital Markets Corp. is the agent.

The Cusip number is 06368EDD1.

The notes were expected to price on Jan. 21 and will settle on Jan. 26.

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