BMO’s $1.08 million autocallable barrier notes on indexes, ETF show eye-catching yield

By Emma Trincal

New York, Sept. 22 – Bank of Montreal offered a significantly high yield on a worst-of autocallable note by introducing an underlying that shows a low correlation with the two others, buysiders said. In addition, this asset is the most volatile in the mix, they noted.

The Canadian issuer priced $1.08 million of autocallable barrier notes with contingent coupons due Dec. 20, 2021 linked to the VanEck Vectors Gold Miners ETF, the S&P 500 index and the Russell 2000 index, according to a 424B2 filing with the Securities and Exchange Commission.

Every month, the notes will pay a coupon equal to 16.25% per year if each asset’s closing level is at least 60% of the initial level on the observation date for that month.

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 March 2021.

If the notes are not called, the payout at maturity will be par unless the final level of any asset is less than the initial level and any asset ever closes below the trigger level, 60% of the initial level, any day 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.

40% threshold

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, said he is not a fan of worst-of, but this one deserved more attention.

“I don’t like the worst-of. You’re looking for the worst of the lot. It’s hard to get any client even remotely interested in that,” he said.

But the 60% barrier levels were “reasonable,” he noted.

“Looking at the S&P this year, even in March the index did not drop 40%. The probabilities that the market would go down by more than 40% in 15 months don’t look that high unless we go through a very deep recession.

“The Russell also would have to go down deeper than it was in March.”

Gold miners

The VanEck Vectors Gold Miners ETF presents more risk.

“It’s a lot more volatile. It would actually be within the realm of reality if it went down more than 40%,” he said.

“Gold miners tend to correlate to stocks. It’s at 40 right now. It would have to fall to 24. This is a level that was hit in March.

“So, it’s realistic to think the ETF could drop to that level again, although it is the strongest of the three. The fund is trading upward, but it’s also the most volatile.

For Chisholm, the above-average coupon was designed to compensate investors for significant risks.

“I just don’t like this particular type of structure.”

Correlations

Jonathan Tiemann, president at Tiemann Investment Advisors, said the notes may not be easy to allocate in a portfolio.

“There is a number of risks in this deal. One of them is the call risk.

“Part of what supports the higher coupon is that you can get called every month, although to be fair, they put a six-month protection in there, which is nice,” he said.

“What’s weird about it is the mix of instruments. They put gold miners with the S&P and the Russell.

“These are quite different animals. I bet the miners is not very correlated to the indices.”

The coefficient of correlation between the S&P 500 index and the gold miners ETF is 0.443, according to FactSet. The Russell 2000 index shows a 0.475 coefficient of correlation with the ETF.

On the other hand, the S&P 500 index and the Russell 2000 index have a 0.93 correlation.

Allocation

The risk-reward characteristics of the notes may be a problem for advisers seeking to optimize the asset allocation of their clients, he said.

“This product it’s designed for investors seeking income, but it has the risk profile of equity. The 16% return is an equity return. However, you’re getting the coupon but you’re not getting the full upside, so that’s not really equity. Plus, you’re further capped by the call feature.

“It sort of has the risk characteristics of equity without the full reward,” he said.

On the other hand, Tiemann said the notes were too risky to be used in a fixed income portfolio.

“First you may not get the coupon. And second, your principal is not protected. The note has a very unpleasant downside. If you hit the barrier your principal is nearly cut in half,” he said.

“What’s really exciting is the headline rate... But there are many risks associated with it. You have the call risk, the market risk, the contingency of the coupon and the worst-of.”

BMO Capital Markets Corp. is the agent.

The notes settled on Sept. 18.

The Cusip number is 06367W5H2.

The fee is 0.25%.

More offerings

Prior to this deal, which priced on Sept. 15, BMO issued on Sept. 9 two other similar products.

Both issues were also distributed by BMO Capital Markets Corp. with the same fee amount. The three underlying assets and the structure were the same.

Only a few terms varied since the notes priced earlier.

One issue with a maturity date of Dec. 14, 2021 (Cusip: 06367W5D1) sold for $2.34 million. The coupon was 16.4% per annum. Everything else, including the call date and conditions were the same.

Separately, BMO priced $1 million of notes due Sept. 14, 2021 with a Cusip number of 06367W5C3.

The 12.55% contingent coupon was lower but so was the barrier at 55%. Again, the other terms were the same, including the monthly payment of the coupon and the six-month call protection.

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