RBC’s $850,000 digitals on biotech ETF show value, high chances of winning, advisers say

By Emma Trincal

New York, Aug. 22 – Royal Bank of Canada priced $850,000 of 0% digital notes with barrier due Sept. 20, 2024 linked to the SPDR S&P Biotech ETF, according to a 424B2 filing with the Securities and Exchange Commission.

If the price of the ETF finishes at or above its 70% barrier, the payout at maturity will be par plus the digital return of 9.5%.

Otherwise, investors will be fully exposed to any losses.

Justified premium

“The one-year Treasury is yielding 5.39% right now. You’re getting a 4% premium for taking on the risk of this sector. Is it a good risk to take on? I think so. This is a fund that has already had a big pullback. The chances of breaching the 70% barrier are probably small,” said Tom Balcom, founder or 1650 Wealth Management.

The notes priced last week at a closing level of $76.95, which set the barrier price at $53.87, according to the prospectus.

That level has not been seen since the end of 2016, he noted.

Moreover, the initial price of the underlying ETF was nearly 17% lower than the 52-week high of February at $92.60, he added.

“If you’re bullish you probably wouldn’t buy the notes. You would go long the shares,” he said.

“But as an income play, you’re getting a nice, juicy yield,” he said.

Balcom said he may put the notes in the bond bucket of his portfolio.

“I could see it as a high-yield exposure,” he said.

Alternatively, given the digital return, he may also use the notes as equity replacement.

“In both cases you want to put it in riskier buckets since the biotech ETF has a higher standard deviation,” he said.

The implied volatility of the SPDR S&P Biotech ETF is 30.31% compared to 17% for the SPDR S&P 500 ETF Trust.

Dividend, diversification

The opportunity cost of not receiving the dividend payment was minimal as the dividend yield of the fund is only 0.13%.

“It’s just a 13-month term and it’s nearly 0% in dividends. So, you’re basically losing nearly nothing,” he said.

The ETF offered other advantages.

The weighting for its top holding, Bridgebio Pharma Inc., was only 2.14%, he noted. None of the other constituents had a weighting in excess of 1.5%.

“You don’t have to take a bet on a few stocks. The ETF is well diversified. You already had a pullback in this sector and the 30% cushion is substantial. You get a nice return even if you’re down 30%. I can see why some investors may have an interest in this note even though it’s a sector fund, which is usually riskier,” he said.

Track record

A financial adviser also liked the note for its risk-adjusted return.

He looked at the chart over the past five years.

“This ETF hasn’t been below $50 in five years. It hit a double bottom at around $62 in May and June, dropped at almost the same level in March 2020 during the early stage of the pandemic. If you look at the five-year chart, you won’t see any level anywhere close to $54,” he said referring to the barrier price.

“Given that track record, it’s not very likely that you’ll breach the 70% strike,” he added.

“That barrier level would be quite a bit below the lows of the last five years. Such historical support is stacking the odds in your favor,” he said.

Post-Covid rally

In February 2021, the ETF share price peaked at $174.74, a level more than twice higher than the current price. The ETF closed at $78.37 on Tuesday.

“People got really excited about the biotech sector. It was like AI today,” he said.

But the upward trend was not limited to this sector.

“It was the big rally that started in March 2020 topping out in February 2021. It was across a variety of asset classes,” he said naming real estate, stocks and high-yield bonds, among others.

After the March 2020 crash, global markets recovered quickly.

“It was a massive, worldwide rebound,” he said.

Upside

The share price currently is trading somewhat at a discount but “not a huge discount,” he noted.

As a result, this adviser is not expecting a big uptrend.

“The 9.5% return is just fine,” he said.

If anything, the fund may be more vulnerable to a pullback by virtue of the fact that the market is overheated at the moment, he said.

“A market drop could easily spill over to other sectors. Weather it would hit biotech, which is not in a bubble, we don’t know for sure,” he said.

While the 9.5% return over 13 months may seem modest for a high-growth sector, the likelihood of pocketing the digital payout was high, which played in favor of investors.

“You don’t get a huge return, but the fund doesn’t have to be up for you to get it. It can drop 30%. Given the record of the fund, the chances of losing money are small,” he said.

“It’s an underlying that’s somewhat undervalued. It’s not trading at a deep discount. But it’s not overpriced either.”

Insiders at the moment are neither buying nor selling, he noted, which made the range-bound view embedded in the trade all the more timely.

RBC Capital Markets, LLC is the agent.

The notes settled on Aug. 17.

The Cusip number is 78016NVC8.

The fee is 1.375%.

© 2015 Prospect News.
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