UBS’ $500,000 buffer securities on S&P MidCap 400 index offer access to forgotten asset class

By Emma Trincal

New York, Feb. 14 – UBS AG, London Branch’s $500,000 of 0% notes due Feb. 13, 2025 linked to the S&P MidCap 400 index provide one-to-one exposure with upside cap and downside buffer to an asset class that is often left behind by asset allocators, said Carl Kunhardt, wealth adviser at Quest Capital Management.

The payout at maturity will be par plus any index gain, capped at 38.3%. Investors will receive par if the index falls by up to 10% and will lose 1% for every 1% decline of the index beyond 10%, according to a 424B2 filing with the Securities and Exchange Commission.

Medium-sized companies

“A lot of people rule out mid-cap in their portfolio as if the asset class didn’t exist,” said Kunhardt.

“It’s a little bit of a forgotten asset class. It’s because mid-cap behaves either like small-cap or like large-cap. There’s no clear dividing line.”

Kunhardt’s rule of thumb is to categorize any company with market capitalization between $4 billion and $10 billion as mid-cap.

“It’s not the exact definition but close enough,” he said.

To be included in the index, companies must have a market capitalization comprised between $3.6 billion and $13.1 billion, according to S&P Dow Jones Indices.

“They’re going to act pretty much like large-cap.

“Asset managers use it because it’s a little bit less volatile than small-cap while it has the potential for higher returns than large-cap.

“You can only slice the U.S. market so much. Mid-cap is not really a distinct asset class,” he said.

A much more relevant distinction is growth-versus-value, he said.

“Within the mid-cap category, just like within other areas of the domestic equity market, growth has outperformed value for a long time. But over the past three or four months, it’s been the opposite. Mid-cap value has been stronger,” he said.

Decision tree

As with any structured notes, the first decision investors need to make is whether they like the underlying index.

“Do I want exposure to mid-cap? I would say: yes, I probably do. It’s giving me the opportunity for a decent rate of return without the full volatility of the small-cap sector,” he said.

“Then comes the key question within the decision process: If I want the exposure, am I better off investing in the note or holding the position long?

“In this case, I’m one-to-one on the upside. There is no advantage in holding the note on the upside.

“On the downside, the 10% buffer gives me the advantage over a long position. It’s attractive even if I’d like a bigger buffer.

The final decision for investors is whether they can tolerate the cap, which is approximately 12% a year, he added.

“Do I accept the cap to get the protection? Do I think that the market over the next three years is going to return more than 12% a year? I don’t.

“An equity class that’s more volatile than large-cap in this environment could lead me to a negative return.

“I think there is more downside risk than upside potential right now.

“So that makes the notes the winner holding the asset class long,” he said.

Tiny buffer

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, who shared Kunhardt’s concerns over the market risk, said the buffer did not offer an adequate answer.

“At least it’s not a worst-of. Good, because worst-of are the worst products out there,” said Chisholm.

“But a 10% buffer on the downside – that’s nothing. I’m not really impressed with that. It’s not much protection considering the risk out there. In the next three years, we’re likely to see a recession or a bear market. 10% is not going to cut it.”

Chisholm said investors were unlikely to be penalized by the 38% cap.

“I’m not worried about the cap. I’d rather have a cap on the downside,” he said.

“What surprises me is that they’re only giving you a 10% buffer. Given that it’s a one-to-one with a cap and a three-year maturity, you would think that you could get more protection.”

Bearish outlook

Chisholm said mid-cap stock investing offered some benefits.

“Generally, companies that make it from small to mid-cap also make it from mid-cap to large-cap. Mid-cap stocks can be seen as an area of potential growth,” he said.

But this adviser’s outlook for the next three years is not optimistic.

“I don’t believe that things are going straight up to the moon, let’s put it that way.

“We’ve been in a bull market since 2009. We had a big pullback in 2020 but came out if it very quickly. It was not like the bear markets of 2000 or 2008.

“We’re probably going to have another bear market, something similar to the early 2000’s...that would be my guess. But who knows?”

With a limited downside protection and limited liquidity, Chisholm said he would not consider the note.

“I don’t know what problem it is solving. I’d rather buy the MDY,” he said.

He was referring to the ticker for the SPDR S&P Mid-Cap 400 ETF, which replicates the performance of the index.

UBS Securities LLC and UBS Investment Bank are the agents.

The notes settled on Monday.

The Cusip number is 90279DYM2.

The fee is 1.5%.

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