UBS’ $280,000 autocalls on Brazil ETF offer access to deeply discounted market, contrarian says

By Emma Trincal

New York, Jan. 6 – UBS AG, London Branch’s $280,000 of trigger phoenix autocallable optimization securities due July 9, 2024 linked to the iShares MSCI Brazil ETF provide one of the best equity exposures from a value standpoint, said a portfolio manager who focuses on value investing.

If the ETF closes at or above the trigger price – 60% of the initial share price – on a quarterly observation date, the issuer will pay a contingent coupon for that quarter at the rate of 15.8% per annum, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, no coupon will be paid that quarter.

If the shares close at or above the initial price on a quarterly observation date, the notes will be called at par plus the contingent coupon.

If the notes are not called and the ETF shares finish at or above the trigger price, the payout at maturity will be par plus the contingent coupon. Otherwise, investors will be exposed to the share price decline from the initial price.

Jailbird back in office

The choice of the Brazilian stock market as the underlying is an advantage for investors, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments, who is long the shares of the ETF.

“Brazil is definitely one of the cheapest markets in the world, one that trades well below fair value,” he said.

The fund, which is listed on the NYSE Arca under the ticker “EWZ,” offers exposure to large and mid-sized companies in Brazil. Part of its current valuation is due to the perceived political risk surrounding the October election of left-wing president Lula da Silva, said the portfolio manager.

“Political uncertainty is a long-established pattern in Brazil and it’s not the first time we see investors overreacting to political confusion and scandals,” he said.

“Lula himself went to jail a few years ago for corruption and is now starting his third term. The concern is that he’s a socialist who’s planning big spending. But those fears are overblown. Chile elected a socialist in December 2021. He hasn’t bankrupted the economy. In fact, the Chilean equity market has gone up.

“This is business as usual in Brazil. Politics always make investors nervous. Investors overreact, the market plummets and then rallies. If you understand the repeated pattern, you can buy low and sell high.”

Scandals means value

Other political events in Brazil have offered dip buying opportunities in the past, he noted, pointing to the impeachment of president Dilma Rousseff in 2016. Brazilian stocks at the time hit their lowest point in more than a decade.

“It didn’t last long. After the panic selling of early 2016, you had one of the greatest rallies of the century,” he said.

“It’s the same thing with Lula. Investors panic, stocks come under pressure, which leads to great bargains.”

Most indicators of the underlying fund suggested deep value, such as the price-to-book of 1.49, he said.

“Anything below 2 is great. Below 1 is rare. So, 1.49 leans toward the low end. It’s much lower than the SPY’s, which is 3.62,” he said.

Still one of the best

The 18-month notes however may be too short to allow long-term gains. But the 15.8% coupon was worth the risk given the entry point and the barrier.

“Overall, I expect the market to be down in the first half of 2023. So, you may hit lower points in April and July and not get called immediately. It’s not a bad thing. In the meantime, with a 60% barrier, you should be able to collect the coupon while holding the notes.”

The initial share price of the fund when the deal closed was $25.89, or nearly 35% off its April high.

“The ETF is not at its most undervalued point. The current share price remains higher than its $16.86 low of the spring of 2020. Of course, there has been a recovery as it should,” he said.

“Brazil however remains one of the best bargains out there. The fund is currently trading at a 25% discount to fair value.”

Risk mitigation

This “margin of safety” was only one among other factors making the note potentially appealing for conservative investors despite the inherent volatility of this emerging market.

The 40% contingent protection was the most obvious risk-reducing factor. But the quarterly autocall provided some protection as well.

“I don’t anticipate any recovery in the global market before October,” he said.

“You may get called in October, which would give you three-quarters of the annual return. That’s an excellent rate of return. The issuer was probably able to give you 11.80% using the high dividends of the fund.”

The dividend yield of the iShares MSCI Brazil ETF is 11%.

Automated discipline

“With the note, you don’t have the upside and you don’t have the dividends. But you have other things...the 40% protection and a series of automatic calls,” he said.

The call option helped mitigate the barrier risk at maturity, he said.

“You’ll probably miss the first two quarters. But with a market like Brazil, which is constantly moving up and down, the call reduces your risk. You may not get the full return. You may not hold the notes for 18 months. But your annualized return is still high,” he said.

Investors who bought the shares outright may have greater upside potential. But they need an exit strategy.

“If you’re long the fund during the next 18 months, you’ll go through huge market swings. If the market rallies, you may be tempted to hold on to your position instead of selling. People don’t always have the discipline to sell when the price is high. In a way, the call takes care of that for you and does it automatically.

“That’s a plus.”

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

The notes settled on Thursday.

The Cusip number is 90286B499.

The fee is 1.5%.

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