UBS’ trigger callable notes on ETF, indexes offer high coupon, ‘speculative’ bet

By Emma Trincal

New York, July 18 – UBS AG, London Branch’s 0% trigger callable contingent yield notes with daily close monitoring knock-in due Oct. 19, 2023 linked to the least performing of the VanEck Gold Miners, the Nasdaq-100 index and the Russell 2000 index pay an eye-catching contingent coupon, but advisers were too concerned about the risks to consider buying them.

The notes will pay a monthly contingent coupon at an annual rate of 23.1% if each underlying’s closing level is at least 65% of its initial level on the corresponding monthly observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be callable at par on any quarterly observation date after six months.

At maturity, if the notes have not been called, investors will receive par if all three underlyings close above their initial levels.

Alternatively, if any underlier finishes below its initial level, investors will receive par if no underlier has closed below its 65% trigger level on any day during the life of the notes.

Otherwise, investors will lose 1% for every 1% that the least-performing index’s final level is below its initial level.

Not easy

“I’m not sure there’s anything in this note I like,” said Carl Kunhardt, wealth manager at Quest Capital Management.

“I like simple notes because they are easy to explain to clients even if you’re managing their account on discretion.

“With this one, it will probably take 10 minutes to describe the terms and then the client has to understand. I’m not taking 20 minutes explaining any investment to a client.

“This note fails the simple-note test.”

Dispersion risk

Kunhardt’s second objection was the use of a worst-of payout, a feature he tends to avoid whenever possible.

“I don’t like worst-of especially if you’re going to pick three indices completely uncorrelated to each other.

“Between the three, something is going to go wrong.

“Tech and gold. Really? And you’re throwing in small companies.

“You really don’t want this note to succeed,” he said.

The coefficient of correlation between the Gold Miners ETF and the Russell 2000 index is 0.26. Between the ETF and the Nasdaq-100 index, the coefficient is only 0.15. In contrast the two indexes show a 0.92 correlation to one another.

Issuer call

Kunhardt was just as critical regarding the downside protection.

“You have this weird barrier, which can be breached any time. That’s extremely risky. I’d rather have this kind of barrier on the coupon. It makes it easier to plan ahead,” he said.

“There are so many things against it.

“I suppose someone wanted a high coupon but lost focus on what a structured note should be.”

For Kunhardt, a structured note “should” first be designed to mitigate market risk. Despite a reasonable size, the barrier failed to fulfill this objective due to the daily knock-in, he said.

Finally, Kunhardt said he would not be interested in a note which the issuer may call on a discretionary basis.

“The issuer call is a non-starter for me right off the bat. Even if you can’t get called in the first six months...Six months go by in a blink.”

“Put it together...you have this barrier, three uncorrelated indices and the issuer call. That’s not something I would be interested in,” he said.

Speculative play

Jerry Verseput, president of Veripax Wealth Management, was more concerned about one of the three underliers than with the structure itself.

“The Nasdaq and the Russell are down a lot already. The 35% additional is probably OK. But GDX is the wildcard,” he said.

The VanEck Gold Miners ETF is listed on the NYSE Arca under the ticker “GDX.”

The Nasdaq-100 index is down 30% from its November high. The Russell 2000 index is 24% off its January high.

“This would be a pure speculative bet,” he said.

Verseput said the deal reminded him of a series of “car notes” done on Ford Motor Co., Tesla Inc. and General Motors Co., paying contingent coupons in the neighborhood of 30%.

One important difference compared to this note however was the fact that the three stocks were part of the same industry.

“But the idea is similar. It’s purely speculative. You’re trying to get the high coupon. If I get 30% great. I made some money,” he said.

American barrier

The Gold Miners ETF introduced more risk due to its volatility as well as its low correlation with the two other underliers.

The implied volatility of the Gold Miners fund at 47.89% is much higher than that of the Nasdaq-100 index, which is 32.08%.

“Who knows what GDX is going to do? We’re in such unknown territory. ... If the barrier was 50%, I’d be OK.

“But this is an American barrier at 35%. There’s not enough protection,” he said.

The term “American barrier” designates a barrier that is monitored during the life of the notes, in this case, on a daily basis.

“I don’t think the Nasdaq and Russell are going to have a problem with a 35% safety margin, even with daily observations. But GDX can definitely spike lower,” he said.

Failing to hedge

The VanEck Gold Miners has already dropped 40% from its 52-week high in April. But Verseput said it could fall even more. At the end of March 2020, the share price bottomed at $16, or 38% off Monday’s closing price of $25.71.

The ETF tracks the performance of companies involved in the gold mining industry. Constructed around 54 constituents, it replicates the NYSE Arca Gold Miners index. The fund’s two top holdings – Newmont Corp. and Barrick Gold Corp. – have a combined weight of 26%.

“It’s too small an index. And gold prices are very unpredictable in this market. You would think gold would be up significantly in an inflationary environment, but it’s not. I’m not sure why but I don’t buy the idea that bitcoin has replaced gold as an inflation hedge. Bitcoin is useless,” he said.

He brought up one possible explanation for the poor performance of the ETF.

“Gold mining is a very capital-intensive industry and capital costs have gone up with inflation, borrowing costs have gone up with higher rates. Maybe that’s the reason.

“We’re in such an unusual, weird economic environment we haven’t been in before.

“There’s nothing wrong with a speculative bet.

“But GDX with a 35% American barrier would kill it for me,” he said.

UBS Securities LLC and UBS Investment Bank are the agents.

The notes were expected to price on July 15 and to settle on July 20.

The Cusip number is 90279FLW9.

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