UBS’ $3.23 million notes on iShares Russell offer high leverage for modest expectations

By Emma Trincal

New York, Nov. 22 – UBS AG, London Branch’s $3,231,000 of trigger return optimization securities due Nov. 19, 2026 linked to the shares iShares Russell 2000 ETF provide investors with a high leverage multiple, which increases the odds of scoring the maximum return. Such payout was designed for investors with limited return expectations on the small-cap benchmark, sources said.

If the iShares Russell fund closes at or above the initial price, the payout at maturity will be par plus five times any gain in shares of iShares Russell capped at 32.46%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the fund declines but finishes above the 75% trigger level and will share in any losses if it closes below the trigger level.

Easy cap

“That five-time leverage is nice. But you’re going to cap out if it’s up 6% in three years. It does cap out pretty quickly,” said Mark Dueholm, chief fixed-income trader at Landolt Securities.

“The problem I have with these notes is that it’s costly not to be paid any interest, especially when interest rates are so high. On a three year, you can make more than 15% just investing in cash,” he said.

The small-cap benchmark is relatively volatile. For Dueholm, the downside protection was not sufficient.

“I don’t love the 25% barrier. I usually try to go to at least 30%,” he said.

One possible appeal of the underlying was its lackluster performance, which provides a better entry point than other benchmarks, such as the S&P 500 index and the Nasdaq-100 index, both more richly valued, he said.

Laggard

“The Russell is way below its all-time high of 2021,” he said.

The Russell 2000 index closed at 1,795.54 on Wednesday, or 27% below its high of Nov. 8, 2021 of 2,458.86.

Meanwhile the S&P 500 index, which closed at 4,556.62, is only 5.4% off its all-time high of Jan. 4, 2022.

“The Russell has been underperforming the S&P for the last two years. It can’t keep up with these mega cap tech stocks that are fueling the large-cap rally. The Russel doesn’t capture that,” he said.

For investors who believe the Russell will continue to lag the performance of the S&P 500 index, the high leverage should be helpful, he said.

However, for more contrarian investors anticipating a reversal, a long position in the index fund might be more appropriate.

“If you’re really bullish, it wouldn’t make a lot of sense to use this note. You would cap out too quickly,” he said.

Five times

A market participant agreed that the notes were not designed for bullish investors.

“It’s almost like a digital payoff. With the 5x leverage, you’re almost guaranteed to get to the cap if the index is up. It really doesn’t have to be up that much,” he said.

The 32.46% maximum return over three years is the equivalent of a 9.82% annualized compounded return. Such a cap may be achieved if the index is up by only 2.12% per year.

“The leverage doesn’t matter that much. It’s more of a cosmetic feature. A digital would give you a similar outcome,” he said.

“This is an alternative way to be bullish on the Russell if you want a 10% annualized return with some downside protection.”

Not a bull play

Buyers of a note linked to the small-cap benchmark are diversifying away from the S&P 500 index.

“The Russell has been lagging the S&P a long time because of the stellar returns of the ‘Magnificent Seven’ in the large-cap index,” he said.

“But this is a trade for investors targeting small-caps only. They’re just looking for enhanced return in their exposure to this asset class.”

The Russell 2000 index, which consists of less well-capitalized stocks, is not without risks.

“From a pricing standpoint, the Russell is attractive because it’s more volatile. If you did this on the S&P you wouldn’t get a cap of 10% a year,” he said.

“I would just buy the Russell if I was bullish on it.

“But I can see the note being valuable to clients who are only slightly bullish and want the exposure along with some protection.”

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

The notes settled on Nov. 17.

The Cusip number is 90304C750.

The fee is 2.5%.

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