UBS callable exchangeable securities tied to six stocks limit downside, price at premium

By Emma Trincal

New York, March 7 - An upcoming note from UBS AG, London Branch tied to a basket of stocks gives investors limited downside risk at the cost of a premium, which in turn limits the upside, in an unusual structure advisers said may be too intricate for retail investors.

UBS plans to price 0.125% callable exchangeable securities due March 15, 2016 linked to a basket of six common stocks, according to an FWP filing with the Securities and Exchange Commission.

The basket includes Apple Inc., Blackstone Group LP and Finisar Corp., each with a 12.5% weight; BorgWarner Inc. with a 17.5% weight; Priceline.com Inc. with a 30% weight; and Schlumberger Ltd. with a 15% weight.

The notes will price at 110% of par.

Interest is payable semiannually.

The notes are callable on any business day beginning March 15, 2014.

If the final basket level is less than or equal to the initial level, the payout at maturity or upon redemption will be par, resulting in a loss of 9.09% to the investor. If the final level is greater than the initial level, investors will receive par plus the gain in the basket. A final basket level of 110 or greater provides a positive return.

Not so bullish

"I would pass it for small clients because it would take a lot of explaining," said Carl Kunhardt, director of investment management and research Quest Capital Management.

"But this note may be interesting for an institutional investor looking to diversify."

Investors make money only if the final basket level is greater than 110, said Kunhardt, as the notes are priced at a premium. Because the 10% premium "is not that big a hurdle for five years," the notes are most likely targeting moderately bullish investors, he said.

"It's a bullish play, and the 10% on the upside is a pretty low bar. It's quite achievable.

"I don't think you have to be that bullish. Apple would do it by itself."

Sophisticated investors

Kunhardt, however, said that the product may not be sound for individual investors as the underlying basket would require some analysis. Some of the stocks are not among the most well-known names.

"You'd have to really research the stocks. Apple is great. But your return depends on the other stocks too," he said.

Kunhardt said that he would "pass" for retail clients because the structure of the product is more complex than most other deals given the premium pricing and the underlying stock basket.

"But for a sophisticated investor, it might not be a bad piece of the alternative investment space. The fact that there are only six stocks makes it easier to follow. It would add to your portfolio some non-correlation. Once the basket is down 10%, you're no longer correlated to the market," he said.

Bulls, bears

For Michael Kalscheur, financial adviser at Castle Wealth Advisors, the deal was too complex to be recommended to clients. In addition, it was not clear who between the bulls and the bears would end up benefiting the most from the notes, he said.

"The biggest drawback is that there are too many unknowns," he said.

"You have six different stocks with six different allocations. You have an unknown timeline with the call feature. You're being sold the notes at a premium.

"You've got a lot of moving parts on a very confusing offering. If you had to explain it to clients, it would be an absolute nightmare."

In addition, Kalscheur said that it was not clear who might benefit from the strategy embedded in the notes.

"It's a very strange product. I don't see a really big payoff," he said.

"You're giving up 10% on the upside to have no more than 10% loss on the downside. I just don't see how this product is the best for you whether you're bullish, bearish or neutral.

"If you're really bullish, why would you want to buy downside protection? A really bullish investor would expect at least 10% a year, not 10% in five years.

"You have to have a bearish mindset to say if the market goes down, I want to limit my losses to 9%. But if you really had that strong feeling that now is the time to hedge, would you really use these notes? Hedging is a very smart move, and I can understand that. But why with this product?"

Kalscheur said the notes would not work as an equity hedge given the underlying basket.

"I would have more understanding of the product if it was based on an underlying index, in which case, you could use that as a hedge - but not with this goofy basket of stocks."

Some of the picks in the underlying basket also made it more difficult to pitch the product to bearish investors, he noted.

"You'd have a really hard time convincing people to be bearish on Apple," Kalscheur said.

The notes are expected to price and settle in March.

UBS Securities LLC is the agent.

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