BofA offers value bet with its $3 million autocallable notes on Biotech ETF, contrarian says

By Emma Trincal

New York, March 4 – BofA Finance LLC’s $2.99 million of 0% Strategic Accelerated Redemption Securities due Feb. 28, 2025 linked to the SPDR S&P Biotech ETF provide investors with an attractively priced underlying, which increases the chances of a positive outcome despite the absence of any downside protection, said a contrarian portfolio manager.

The notes will be called at par plus a 13.5% annualized call premium if the closing level of the ETF is greater than or equal to its starting value on any annual observation date, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called at maturity, investors will lose 1% for each 1% decline in the ETF from its initial level.

Valuations

“The SPDR Biotech fund is undervalued. Profit growth is much higher than the P/E ratio. That’s a very good sign,” said Steven Jon Kaplan, founder of True Contrarian Investments.

“Some of the companies in the ETF brought new and successful products, which have generated growth. The group has shown consistent profit growth and good value. But since the price has dropped, it has become unpopular for no logical reason,” he said. “People like to buy what goes up and they rush to sell what goes down. They keep on piling in tech stocks, which are still extremely overvalued.”

Kaplan said it’s not clear why an asset or asset class may suddenly trade downward despite good fundamentals.

“Anything can go out of favor anytime. It can be some short-selling; it can be somebody downgrading the stock.

“People don’t pay attention to the fundamentals, especially the relationship between growth and price-earnings ratios. They focus on the headlines. But what really drives the market are valuations.”

Diversification

Another advantage of the ETF is its high level of diversification, he added.

“When you think biotech, many people think Covid therapeutics or Covid vaccines because it’s in the news. But not many companies are involved with Covid in the fund. It’s a very diversified portfolio,” he said.

“You have 189 holdings in there. Most other funds have 40 or 50 stocks. This one has a huge, long list.”

The top holding, for instance, Arena Pharmaceuticals Inc., has a weight of only 1.83%, he noted.

“This fund is very spread out and that helps minimize risk,” he said.

Entry point, term

When the deal priced, the shares of the SPDR S&P Biotech ETF closed at $88.68, nearly 50% off its all-time high of February 2021.

“The entry point for people who bought the notes is reasonably good. It’s not perfect but it’s good,” he said.

“I’m long the shares and my own entry point is between 80 and 84. So it’s still reasonably close. At least it’s below 90.”

Kaplan said he would have preferred a longer maturity.

“Three years is not ideal. I usually look for more time. Five years would have been better.

“The longer you go, the less risk you take. Market fluctuations in the short run are unpredictable. Look at Ukraine. There’s a lot of uncertainty over the short term,” he said.

Memory

Certain terms in the structure were attractive enough to offset some of the negative aspects of the deal.

Kaplan pointed to the memory feature. If investors “miss” the call at the end of the first year, they may get paid at the end of year two with a 27% premium. On the final observation date, the potential return is 40.5%.

“I always favor cumulative payouts rather than a binary coupon where you either make it or lose it. The call premium may be harder to get than a coupon since you need to be above the initial price. But I still prefer to be able to catch up later if I miss one or several calls,” he said.

“So, I like this in the note. The premium is still at risk. But it’s a limited risk.”

Margin of safety

The market risk at maturity should not be overlooked, especially with the full exposure to the underlying price decline. But again, other factors contributed to reduce it.

“The fact that there’s neither barrier nor buffer is not ideal. But because the fund is so under-valued, I’m willing to take the risk,” he said.

“Having those calls also helps, along with the memory.

“It’s a tradeoff. It’s not a perfect note. Most of them are not.

“But at least you have a decent chance of succeeding.”

Ladders of orders

While Kaplan prefers buying the shares outright, he endorsed the choice of the underlying ETF for investors seeking exposure to the security via a note.

“I’m long the ETF but if I was buying the structured product, I would be happy with that type of underlying because it’s one of the most undervalued funds. It’s hard to find that kind of thing especially in the U.S.,” he said.

Kaplan said he is still buying the ETF for its value and potential upside.

“I’ve been buying every time the price drops. I started to buy below $87 a share and I added to my position every time it drops 20 cents, which took me all the way down to $81.79 cents. On average I’ve been buying below $85.”

The share price closed at $83.90 on Friday.

Kaplan explained how insiders’ behavior helps him determine his entry point.

Follow the smart money

“Insiders have been buying the fund a lot recently,” he said.

“My philosophy is that insiders tend to be on the right side of the trade. They wait for the stock to drop. They see how undervalued the security is, based on the relationship between P/E and profit growth.

“I’m comfortable with that approach. A note tied to this particular asset has some potential in my view, even at the level they priced the deal at. It’s still a decent level.

“Too often, the notes I see are linked to overpriced, overcrowded names. It’s nice to see something different.”

The notes are guaranteed by Bank of America Corp.

BofA Securities, Inc. is the agent.

The notes settled on Tuesday.

The Cusip number is 09710F330.

The fee is 2%.

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