UBS' trigger PLUS tied to WisdomTree Japan Hedged ETF offer alternative payoff to fund exposure

By Emma Trincal

New York, Sept. 24 - UBS AG, London Branch's 0% trigger Performance Leveraged Upside Securities due Oct. 5, 2016 linked to the WisdomTree Japan Hedged Equity fund offer an alternative to a long-only exposure to Japanese stocks, but whether the notes are a better choice than the fund depends for the most part on how much investors will value the protection, sources said.

The payout at maturity will be par of $10 plus 1.5 times any fund gain, up to a maximum return of 44.5%, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the shares fall by up to 20% and will be fully exposed to the decline if the fund falls below the 80% trigger level.

Alternative exposure

Dean Zayed, chief executive officer of Brookstone Capital Management, said that the notes may offer a better alternative than the exchange-traded fund.

"If somebody wants exposure to Japan, in lieu of just being long-only, this note may be a better alternative than the ETF," he said.

"Of course, anyone buying Japan would know that the Japanese economy has been through a rough ride for over 20 years. But if you're interested in that particular market, these notes represent a smarter way to get exposure. It has leverage on the upside; it has downside protection. It's an attractive way to get into that asset class because a long-only position simply can't give you those benefits.

"If you're not too comfortable being long-only Japan given the history Japan had, then holding these notes makes sense as they give you a 20% level of contingent protection. Having leverage on the upside is great too. You have a decent cap. And three years is not a long-term note; it's actually relatively short term."

An advantage common to the fund and the notes is the currency hedge, he noted.

The fund neutralizes exposure to fluctuations of the Japanese yen relative to the dollar, aiming at delivering higher returns when the yen is weakening against the dollar, according to the prospectus.

The dollar rose relative to the yen when the market speculated about an upcoming "tapering" of the Federal Reserve's bond buying program but weakened after the central bank announced last week the postponement of the widely anticipated move. The yen also lost ground against the dollar amid an aggressive stimulus policy put in place earlier this year.

With the anticipation of higher interest rates in the United States and more investors turning bullish on the dollar, U.S. investors in foreign equity markets are facing increased risks of losing returns due to the strengthening of the dollar. As a result, they have shown an increased appetite for currency-hedged ETFs such as the WisdomTree Japan Hedged Equity fund. The fund is up 32% this year and 52.6% over the past 12 months.

"Japan has implemented a monetary stimulus which should benefit their market, so I would say it makes sense to be bullish," Zayed said.

"I would have some exposure as a satellite position, not a core position. The currency hedge is probably a good thing as it protects you against the yen depreciation against the dollar, which we've seen happening as a result of the recent monetary easing policy in Japan. So being currency neutral is a good thing."

Costly protection

Jonathan Tiemann, founder and chief investment officer of Tiemann Investment Advisors, LLC, said that cautious investors may find the notes appealing for the downside protection they offer. But he questioned the cost of the protection.

"The cap is about 13% a year if you annualize it. It definitely gives you some upside. But a cap is a cap. It limits your return. What the cap does is ... offer a solution on how to pay for the protection on the range from zero to minus 20 and for the 1.5 times leverage.

"The question I'm always asking myself is, Who would like this return better than owning the fund? If you're bullish on Japan, why not buy the ETF and be done with it?

"The three-year term is not short term. It's more mid term. You're stuck for three years, and you get UBS credit.

"We sure know how liquid it's going to be. But it's usually a good policy not to expect any liquidity at all. It's the safer way to play it.

"This product is for someone who really needs the protection and who is ready to pay for it because in order to get it, you agree to cap the upside, take on the credit risk and have limited liquidity."

Tiemann said that any risk mitigation tool will have a cost. But investors should compare the cost versus benefits of all options available to them.

"If you bought a put, it would cost you the premium, but you would get the protection all the way down once you're in the money.

"A stop loss would be a better option. You can also calculate the amount of loss you can tolerate, but it won't cost you anything. Of course you will lose some of your money when the stop is triggered. But that's the amount of losses you have decided you were comfortable losing, and that amount is by definition limited. If you have no tolerance for losses at all, imagine what it's like to have a three-year note and to sit there while the value of the underlying index is dropping. This fund could drop easily 20% or more in the next three years. You may be able to put the notes back to the issuer but at a sacrificed price.

"The buffer is a better type of protection in theory. But having a 20% buffer would change other parameters too, and you would have to pay for it as well. It would cost you more if it was the same amount of protection, probably in the form of a lower cap or a longer duration.

"There's nothing wrong with Japan. Japan has been very aggressive with the stimulus. It's hard to know if it will work. I hope it does. Having an allocation to Japan makes sense. I'm just not sure whether it makes sense to do it through a structured note that ends up costing you a lot in return potential."

UBS Securities LLC is the agent. Distribution is through Morgan Stanley Smith Barney LLC.

The notes will price Monday and settle Oct. 3.

The Cusip number is 90271M443.

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