UBS’ $675,000 contingent absolute return autocalls on Brazil ETF positioned for defense

By Emma Trincal

New York, Sept. 24 – UBS AG, London Branch’s $675,000 of 0% contingent absolute return autocallable optimization securities due Sept. 25, 2023 linked to the iShares MSCI Brazil ETF offer an attractive downside payout, which could help hedge a global market meltdown, said bearish investor Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

The notes will be called at par plus a call return of 12% per year if shares close at or above the initial share price on any observation date, which occurs every two months, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called and shares finish at or above the trigger price, 49.05% of the initial share price, the payout at maturity will be par plus the absolute value of the ETF return. Otherwise, investors will be exposed to the share price decline from the initial price.

“The most likely scenario is that you’ll get called away at some point because the fund will be up by more than the offering price. If it takes a little while you could collect several more coupon payments,” said Kaplan.

“It’s a fairly favorable structure for the buyer.”

Deep absolute return

But the more “intriguing” part of the structure was the downside.

“You get a pretty generous barrier,” he said.

“It covers you up to 51%. If you go back to the March 2020 bottom, the drop in price was less than that.”

Current valuations in the Brazilian market provided an additional margin of safety, he said.

“Brazil is one of the most undervalued markets in the world.

“You’re not starting all the way up on the top like in the U.S. stock market. It’s much more favorable.”

The notes are not designed for bullish investors, he noted.

“If we have a big rally in the Brazilian market over the next couple of years you might wish you were just long,” he said.

“On the other hand, if the share price goes down, you are very well positioned, not only with your 51% protection but also with the ability to make money in that range as well, and it’s quite a wide range.”

Scandals and bottoms

Kaplan said that Brazil is not immune from political risk.

“You could certainly have some negative events in this country. Brazil is known for its crises and scandals, which inevitably have a negative impact on stock prices. It has happened a number of times in the past,” he said.

He pointed to a scandal during the presidency of Dilma Rousseff in 2015. Her impeachment in 2016 caused the market to bottom. Stock prices rebounded until the emergence of a “mini scandal” in 2018 leading to another market low, he said.

“Despite these ups and downs, there is a small chance the share price of the Brazil ETF would go down more than half especially when you’re not anywhere near a market high,” he said.

“This ETF saw an 80% drop in 2016. But again, I don’t think we would have such a collapse today. Of course, it’s possible but it’s not likely simply because current valuations are already deeply depressed.”

Risk at home

Kaplan drew a distinction between risk and volatility.

“When looking at emerging markets like Brazil, people immediately think volatility. And while it’s true that the Brazilian market is more volatile than the U.S., it is in my view less risky because it’s trading at much more favorable valuations,” he said.

He pointed to the U.S. equity market as the world’s epicenter of risk.

“Nowadays, people don’t pay attention to earnings and value. But the P/E of most U.S. technology stocks are dangerously overpriced. Prices investors are willing to pay are enormously higher than earnings,” he said.

Bargain price

As a result, Kaplan’s biggest concern was the domestic stock market.

“We are going to experience a large percentage correction in the U.S market, which will have a contagion effect on the rest of the world,” he said.

“The main risk for Brazil is the spillover from a big drop in U.S. markets more than the political risk inherent to this country, which will still be there but will be secondary.”

Kaplan said he does not rule out a 70% decline in U.S. stocks. But Brazil should fare better, he said.

“The Brazil ETF right now is trading at a 20% to 25% discount to its fair value,” he said.

“In comparison, the Nasdaq is priced at 3.5 times its fair value, which is a huge premium. This is a clear signal that we’re heading toward a major correction.”

Defensive strategy

Kaplan said he liked the note for its defensive structure.

“It’s a conservative investment,” he said.

“You have a deep, generous barrier that allows you to make money down to a 51% decline,” he said.

The payout, he added, is skewed toward a bearish view given that the maximum gain from the coupon is less than half the potential absolute return on the downside.

“It’s a plus to have that kind of structure coupled with a deeply undervalued asset class given the tangible risk of a collapse in the U.S. stock market, which would have ramifications on global equities, including emerging markets like Brazil,” he said.

“Issuers should do more of those kinds of notes. Your upside is capped but the cap is reasonable. And the chances of losing money are significantly reduced.”

UBS Financial Services Inc. and UBS Investment Bank are the underwriters.

The notes (Cusip: 90301A641) settled on Sept. 22.

The fee is 1.5%.

© 2015 Prospect News.
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