UBS’ $1.28 million of autocalls on MSCI Germany offer good value, ‘reasonable’ structure

By Emma Trincal

New York, Sept. 2 – UBS AG, London Branch’s $1,275,000 of 0% contingent absolute return autocallable optimization securities due Aug. 29, 2024 linked to the iShares MSCI Germany ETF offer a pure value play, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments, who approved the choice of an unusual, somewhat unpopular underlying.

The notes will be called at par plus a call return of 13.5% per year if the shares close at or above the initial share price on any observation date, which occurs every quarter, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called and the shares finish at or above the trigger price, 55.44% 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.

Cheap underlying

Kaplan, who focuses on value investing, said he was pleased with the choice of the underlying.

“It’s rare to see a single country ETF in a note,” he said.

“This one is a particularly good pick because Germany is one of the most undervalued markets in the world and certainly the most undervalued developed market,” he said.

The ETF is also deeply “out-of-favor,” which is attractive for contrarian investors, he added.

The iShares MSCI Germany ETF comprises the stocks of 60 large and mid-sized companies in Germany. Its top holdings include tech multinational SAP SE, Siemens AG, Allianz Group, Deutsche Telekom AG and Bayer AG.

“This ETF has dropped a lot and there is a psychological component to it. The negative headlines about the war in Ukraine and the strong dependence of Germany on Russian gas have led people to run for the exit,” he said.

The fund closed at $21.63 on the trade date, 41% off its high of June 2021.

The ETF is also cheap because stock prices are falling worldwide, he added.

“We are in a global bear market.

“The fact that the underlying is already in a downtrend works to the benefit of noteholders. You always want to buy stocks at the right level, ideally at a deep discount to fair value, not when they’re overvalued and overpriced like most U.S. stocks,” he said.

Cumulative premium

One structural aspect of the notes, the cumulative payout, was also very advantageous to investors, he said.

“It helps because the initial direction will probably be lower along with the U.S. market. Then it will likely recover to somewhere above where we are now, which could eventually trigger a call with a decent profit. Most likely the call will happen after three to five quarters,” he said.

Kaplan said the market is likely to hit a temporary bottom in the fall or the winter.

“It won’t be the end of the drawdown, just a break for a few months as it always happens in a bear market.”

“We may have a chance to see a rebound, and if so, I would say it could be at the earliest in February, possibly in May. Those would be the earliest times you may be called.”

In a bear market, getting 13.5% per annum would be an honorable performance, he said. For the more upbeat investors expecting a higher return from the depressed underlying, the note would not be appropriate.

“If you’re bullish, you can always buy the shares,” he said.

Kaplan uses the volatility as an indicator to time his long positions.

“I would wait for the VIX to rise above 60. I would wait for the bottom to buy the shares,” he said.

Inversely, the contrarian portfolio manager looks for the VIX to drop below 20 to enter a short position in some of the most overvalued U.S. securities, such as the Nasdaq.

Absolute return

On the downside, the low barrier offered “plenty of protection,” he said. The absolute return, which is available if the ETF price falls by up to 44.56%, provided an attractive outcome in a down market.

“It’s a nice backup if the German market doesn’t recover and remains depressed for the next two years, which is definitely possible. In that scenario, you could end up with a very attractive return. You would significantly outperform the fund,” he said.

While the absolute return feature was appealing, in part because the maximum return it offers is much greater than the call premium, Kaplan said investors may not need it.

“The absolute return gives you additional safety. I wouldn’t count on it as a way to make a greater profit. I wouldn’t buy the note for that feature,” he said.

Good fundamentals

The MSCI Germany fund is likely to recover given its “great fundamentals,” he said.

“The fund has been hit by negative news since the war in Ukraine. But people don’t look at valuations. It has a P/E of 10.9, a relatively low price-to-book and a high dividend yield. These are all signs of an undervalued market,” he said.

The headlines had an exaggerated impact on the share price, he said.

“None of what was reported by the media can justify why this market is down twice more than the U.S.,” Kaplan said.

Market cycles

In the meantime, however, Kaplan sees a few more months of market decline.

“We’re in a global bear market. It began last year in Europe and started eight months ago in the U.S.

“There will be more pain ahead including for the German market. But over two years, I don’t think the ETF will finish below the issue price. We’ll start to see a rebound next year and maybe early in 2024,” he said.

This made the memory feature “essential” as it allowed investors to navigate the bear market for several months without missing any payment by the time the notes mature.

“This is a nice note. I like the exposure to Germany, and the product is reasonably structured,” he said.

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

The notes settled on Aug. 30.

The Cusip number is 90303X177.

The fee is 1.5%.

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