BMO’s 9% autocalls tied to SPDR S&P Oil & Gas show inadequate risk-reward, advisers say

By Emma Trincal

New York, Dec. 15 – Bank of Montreal’s 9% autocallable cash-settled notes with fixed interest payments due Dec. 29, 2017 linked to SPDR S&P Oil & Gas Exploration & Production exchange-traded fund carry too much risk for fixed-income investors and show little appeal to investors seeking equity-like gains via the sector play, said Steve Doucette, financial adviser at Proctor Financial.

Interest will be payable monthly, according to an FWP filing with the Securities and Exchange Commission.

The notes will be called at par plus the coupon if the fund closes above the 110% call level on any monthly call date beginning July 26, 2017.

The payout at maturity will be par plus the coupon due unless the fund finishes below its initial level and closes below the 70% trigger level during the life of the notes, in which case investors will lose 1% for each 1% decline.

Barrier

“Oil has been very, very volatile lately. It’s been up and down. You’re collecting a 9% coupon for unlimited downside risk on any day. You bust that barrier and you’re taking on a huge risk,” Doucette said.

He was referring to the greater risk involved with so-called “American barriers” such as this one, as they strike any day compared to the commonly used “European barrier,” which is only observed at maturity.

Volatility a factor

“Your coupon is capped. If the oil index jumps in price, you’re not going to capture the upside and it can go down just as quickly,” he said.

Since its low in February, the shares of the underlying ETF have surged 78% this year.

In the one-year period following the peak of mid-June 2014, the price tumbled 40%.

“This risk-reward doesn’t make any sense to me,” he said.

Potential investors eyed

One of the main problems with the product was to identify the types of investors who may benefit from it.

“These autocalls are typically used as fixed-income substitute. Here you get paid 9% a year regardless of the underlying performance. But it’s not a bond substitute. We can’t take that much risk for income,” he said.

Jonathan Tiemann, president of Tiemann Investment Advisors, said he was unsure who might invest in the notes.

“This is someone who looks for exposure to the sector. You see oil potentially going down but not that much or maybe it’s going to go up but not that much either. You’re happy to cut some of your upside for some protection,” he said.

Downside in focus

But the contingency and amount of the protection would probably not be enough for oil stocks.

“The volatility hurts you with a 70% American barrier. It’s easier to breach than point to point,” he said.

However, the fixed coupon of 9% added some safety.

“If I had to compare it to the ETF, if it’s down, I’m better off with that note than with the underlier, just because of the amount of the coupon...at least from that risk mitigation standpoint.

“It’s like having a 9% buffer,” he said.

Also the short term of the note was beneficial compared to other structured products.

“Some of the usual issues like credit risk exposure and lack of liquidity are greatly reduced here,” Tiemann said.

Capped return

More problematic perhaps was the upside. Tiemann considered the 9% coupon as an equity-like return, but one that may limit a lot the potential gains given the volatility of the underlying fund.

The fund’s price has increased by a third over the past one year.

“You’re very severely capped with this coupon,” he said.

“Not only you don’t get any appreciation but you can get called early if the underlying is up 10%, which means that you won’t even get your full coupon.

“I don’t especially like the risk-reward of this note.”

BMO Capital Markets Corp. is the agent.

The notes (Cusip: 06367TNX4) will price on Dec. 22 and settle on Dec. 30.

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