BMO’s autocalls with contingent coupon on indexes, gold ETF show high yield, riskier barrier

By Emma Trincal

New York, March 8 – Bank of Montreal’s autocallable barrier notes with contingent coupons due June 13, 2022 linked to the lesser performing of the S&P 500 index, the Russell 2000 index and the VanEck Vectors Gold Miners ETF offer attractive features but the introduction of a volatile underlying in the asset mix along with a riskier barrier type were “deal breakers,” according to two financial advisers.

Pluses

Among the positive aspects of the structure is the monthly contingent coupon of 14% per year payable if each underlying is at or above a 65% coupon barrier.

The notes are automatically called at par plus the contingent coupon if each underlying asset closes above its initial level on any monthly observation date, according to an FWP filing with the Securities and Exchange Commission.

An additional advantageous feature is the six-month call protection over a 15-month tenor, advisers said.

Minuses

Less attractive, according to them, is the trigger used to determine the amount to be repaid at maturity. The structure features a trigger known as an “American barrier”, which means that it can be breached on any trading day. Set at 60%, this barrier, if hit, will eliminate the downside protection at the end. Investors in this case will be exposed to the decline of the least underlying asset from its initial level. They no longer benefit from any protection.

Gold in the mix

“None of these indexes are likely to drop,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

“The S&P is not going to drop 40%. The Russell may, but it’s unlikely.

“The only thing that concerns me is that you have here apples and oranges.”

Kunhardt examined the worst-of payout, pointing to the relationships between the equity indexes and the gold miners ETF.

The coefficient of correlation between the gold miners ETF and the S&P 500 index is only 0.21 while the coefficient between the Russell 2000 and the ETF is 0.29.

“Both have a low correlation. It’s closer to zero than one,” he said.

The lower the coefficients (measured on a scale of -1 to +1) the greater the dispersion risk since the underlying may not move in the same direction.

In contrast, the S&P 500 index and the Russell 2000 index move much more closely together, showing a 0.91 coefficient.

Diverging fundamentals

“Even though the VanEck is a stock fund, it’s a different animal...it’s poorly correlated with the indexes,” he said.

“The biggest problem is that everybody runs to gold when they’re scared about the market and they dump it when stocks become attractive again,” he said.

“I wouldn’t call gold a flight to safety. It’s way too volatile for that. But the perception is that it has a negative correlation to stocks. While it’s not negative, it’s still a pretty low correlation.

“So, you could have the S&P and the Russell do very well while the ETF is doing not so well.”

Growth or income

The key question for advisers is to decide whether the notes qualify for income or for growth. Even with the high coupon, the product is income-oriented, he said. Yet it failed to meet the criteria for income, he added.

“As attractive as a 14% coupon is with monthly payments and no call for the first six months, if I’m talking income, I want stability. Am I willing to take the risk of a worst-of and the volatility of gold without the growth? I don’t think so,” he said.

But the real “deal breaker”, he said, was the daily observation for the final barrier.

“If it was point to point, I might be more inclined to consider the notes. But since they’re observing the barrier any day in addition to throwing in there the gold along with the two indexes, I wouldn’t do it,” he said.

“The minuses outweigh the pluses.”

American barrier

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, also found in the American barrier an obstacle nearly impossible to overcome.

“It’s terrible!” he said.

“I like the idea of the 14% given the short maturity. That’s appealing. You’re getting a 40% protection on the worst of these three, again given the short maturity, it’s appealing too.

“The challenge is this barrier that can be breached any time. And when it breaches, you lose your protection.

“You’re getting the full downside risk but not the full upside to compensate you for this.

“It’s relatively compelling if the barrier is point to point. But I don’t like this barrier.

“If last year is any guide, anything could happen and destroy this protection.”

When the Covid-19 pandemic hit early last year, the VanEck Vectors Gold Miners ETF dropped nearly 50% from Feb. 24 to March 16.

“You could have one of the three drop 40% and recover. But it doesn’t matter. Once you breach, you breach. This barrier is not appealing at all.”

BMO Capital Markets Corp. is the agent.

The notes were expected to price on March 8 and to settle on March 11.

The Cusip number is 06368EGN6.

© 2015 Prospect News.
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