BMO’s $1.35 million autocallables on index, ETF offer high contingent yield, correlation play

By Emma Trincal

New York, June 25 – Bank of Montreal’s $1.35 million of autocallable barrier notes with contingent coupons due Sept. 20, 2021 linked to the VanEck Vectors Gold Miners ETF and the Russell 2000 index is structured around two low-correlated assets, allowing to extract an unusually high coupon and build competitive barriers, making the product stand out, advisers said.

But the term is too short in the current market environment marked by volatility and uncertainty, they added.

Every month, the notes will pay a coupon equal to 18.4% per year if each asset’s closing level is at least 60% of the initial level on the observation date for that month, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically redeemed at par plus the contingent coupon if each index closes above its initial level on any observation date beginning in December.

If the notes are not called, the payout at maturity will be par unless the final level of either asset is less than its initial level and either asset ever closes below 55% of the initial level during the life of the notes, in which case investors will lose 1% for each 1% decline from the initial level of the least performing asset.

Low correlation

“It’s actually quite a good note. You get some solid level of protection, 45% down,” said Steve Doucette, financial adviser at Proctor Financial.

“The 18% coupon is huge.

“The only thing is you’re dealing with non-correlated assets.

“Look at a chart...there’s quite a spread. Obviously, they’re going in opposite directions. That’s how you get this amazing coupon.”

The one-year coefficient of correlation between the Russell 2000 and the VanEck Vectors Gold Miners ETF is 0.44.

As a comparison, the Russell and the S&P 500 index have a 0.94 coefficient of correlation.

Six-month no-call

The notes cannot be called before December, another attractive term, he said.

“Theoretically, if they both stay above 60% each month, you could walk away with more than 9% in six months.

“And since it’s a very short-term note, you may collect your coupon all the way to maturity and get your principal back. The 55% barrier is pretty good. But of course, who knows? You also have two volatile indexes.”

Price swings

The ETF can drop more than 45%, he said.

Between September 2012 and July 2013 for instance, the fund shares fell by 51%. Between a high in September 2011 and a low in January 2016, the price dropped a whopping 81%.

“They’re both non-correlated. One is very volatile. I mean can you run the risk on the gold miners?

“The small-cap is still down from its high, so there’s less risk with the Russell.

“But if the economy falls again, small-caps could get crushed.

“I think both could drop.”

Investors with opposite views could lose for opposite reasons, which increases the odds of a negative outcome.

“If the market takes off, gold can get killed. If the market goes down, the Russell gets slaughtered,” he said.

Renewed fears

Part of the problem when considering the note as any other investment right now, he said, is the current market environment, marked by heightened volatility and a lack of visibility on the economy.

Recent resurgence of coronavirus cases has put stock prices under pressure over the past few days while the market rallied last week on strong economic news. The pandemic is a constant factor of uncertainty, said Doucette.

Time horizon

“It’s a nice note. But if it was a little bit longer, I may be more inclined to do it,” he said.

“If the coronavirus comes back this winter and we get this double hit on the economic side of this equation, you may not be able to collect your coupon and you could in theory breach that barrier at maturity.

“If we could be floating along for the next 15 months that would be perfect. But that would imply an average market. Unfortunately, there’s nothing average with what’s happening right now and the magnitude of the changes in stock prices.”

Doucette said he would be open to give up some coupon in exchange for an extension of the duration.

“You want to be beyond the coronavirus crisis when this thing matures,” he said.

Despite the tenor issue, he said he liked the product.

“It’s actually quite a neat note.

“Somebody has been thinking outside the box.

“They paired two uncorrelated indices with this unbelievable rate of return,” he said.

Volatility

Matt Medeiros, president and chief investment officer at the Institute for Wealth Management, also expressed concerns about time in relation to the volatility of the underliers.

“They’re both volatile indices,” he said.

The implied volatility for the Russell 2000 index and the gold miners ETF is 42% and 44%, respectively.

“Because it’s a short investment period, it appears to be a little bit risky.

“The miners have recovered quite well relative to the March bottoms. But the Russell has not regained its level from its peak.”

The Russell is trading 19% off its January high.

The VanEck Vectors Gold Miners ETF has more than doubled from its $16.18 low in mid-March to $32.64, its price on the trade date.

Too short

“But the point is they’re both volatile. And you increase the volatility when you shorten the timeframe.

Medeiros alluded to the increased uncertainty felt in the market with the surge of coronavirus infections in several states, which has investors spooked about the economic recovery.

“I don’t know where the market is going to be given the potential headwinds to the economy,” he said.

Medeiros said a longer tenor would make him feel more comfortable.

“I don’t know if I would be willing to take on this bet given the volatility we’re seeing in the market.

“It’s hard to quantify whether or not you’re picking the right 15 months or the wrong 15 months.

“These two indices are incredibly volatile. I don’t see any reason to purchase volatile securities at this point,” he said.

BMO Capital Markets Corp. is the agent.

The notes priced on June 16.

The Cusip number is 06367WR70.

The fee is 0.25%.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.