UBS’ capped airbag gears on Vanguard Real Estate index ETF designed for slower, steady growth

By Emma Trincal

New York., April 16 – UBS AG London Branch’s 0% capped airbag gears due May 19, 2022 linked to the Vanguard Real Estate exchange-traded fund work best in a range bound market for a sector that has been so far very bullish, sources said.

If the final ETF return is positive, the payout at maturity will be par plus 2 times the ETF return, subject to a maximum gain of 10.25%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the final level of the ETF falls by up to 10% and will lose 1.11% for each 1% decline beyond 10%.

The final level will be the average of the index closing prices of the five trading days preceding the maturity date.

Booming sector

“The REITs market has gotten a little bit ahead of itself,” said Clemens Kownatzki, finance professor at Pepperdine University.

REITs are real estate investment trusts, which generate high income for investors.

“Real estate has performed extremely well...not in all segments but depending on the regions, it has in some cases doubled since a year ago,” he said.

“It’s been a fantastic ride.”

But Kownatzki was not convinced about the soundness of the structure.

“I’m not sure I understand why anybody would want to double this. I see the point in a way: this sector is toppish, so you don’t expect a big move on the upside. But then you have to look at the downside. That 10% buffer isn’t really that much,” he said.

The fund has gained more than 45% since its low of May. It was trading at around $96 on Friday afternoon.

Sleeping tiger

“If you really expect more upside, why not go into the ETF directly and hedge yourself? That would be my preference because I’m more concerned about the downside risk,” he said.

Kownatzki said the real estate sector as a whole is exposed to interest rate risk. Some of the contributing factors to its growth have been the Covid-19 pandemic itself, which has led people to sell their homes and buy in other states or away from big cities. Now the economic reopening seems encouraging as well. But that’s without counting inflation, which is a threat to the sector.

“People believe that inflation is not going to be an issue, that the Fed has timed everything to perfection,” he said.

“But we, the older crowd have seen that before.”

“Inflation is like a tiger. If you try to tame the tiger, you’ll have to catch it by the tail,” he said, noting that he was paraphrasing Austrian economist F.A. von Hayek’s famous metaphor.

“The Fed has been printing trillions of dollars. They’re awakening the sleeping tiger. When inflation goes up, rates go up, especially mortgage rates.

“Real estate goes south at that point, especially in the U.S. where buyers are deeply leveraged and depend on the financing rate.”

Another negative impact of inflation resides in the bond-like nature of REITs. The underlying fund could sell off if interest rates go up because REITs are bought essentially for their above average yields.

“The inverse relationship between price and yield is not as drastic as it is with bonds, but it’s there,” he said.

The Vanguard Real Estate ETF pays a 3.8% dividend.

Collar hedge

Kownatzki, who is also an independent currency and options trader, said he would be more comfortable using a collar strategy for a hedged position in this ETF.

“If I wanted exposure to this ETF, a trade that would make more sense to me would be a collar. It would not replicate exactly what the note does. But my protection would be much stronger. No leverage on the upside, but no geared buffer either. It’s simple and I know my risk,” he said.

“If I strike the put at 90, I’m protected below that level.”

The collar is an option strategy that consists of writing a call, effectively capping the upside and using some of the received premium to buy a protective put.

“The cost of the collar is not that significant. It would also have a shorter maturity.”

That’s because standardized listed options for the Vanguard Real Estate ETF do not carry contracts matching the exact 13-month length of the notes. The closest expiration date would be Jan. 21, 2022, according to the options chain, which would cut the duration of the trade by four months.

“People buying the notes assume that this ETF is not going to go down 10% or more. I find it to be a risky bet,” he said.

Undesirable cap

Jeff Pietsch, founder of Eastsound Capital Advisors, had a bullish view on the asset class and therefore objected to the cap more than to the protection, although he said he did not like the “accelerated” part of the buffer.

“We are in a procyclical market. I include real estate, which has benefited from low interest rates,” he said.

“I’d rather own the VQN one-to-one and let it ride.”

The Vanguard Real Estate ETF trades on the NYSE Arca under the ticker “VQN.”

“The Fed has indicated that interest rates are likely to remain low for another year or maybe two.

“People have been buying homes all over the country, relocating to different places or states during the pandemic.

“I wouldn’t want to place restrictions on my return, and I’m not too concerned about the downside.”

Short-term

There were however some risks to consider when seeking exposure to REITs.

“The commercial real estate segment is still fragile. People have slowly begun to go back to work. But leases have been broken and the stay-at-home trend may or may not last; we’re still going through this structural change...

“Rates are also rising.”

But the short tenor of the notes lessened most of the uncertainty.

“It’s only a 13-month trade. That’s short term. I don’t foresee significant risks during that period,” he said.

Given his bullish outlook, this adviser concluded that the note offered no particular advantage compared to owning the fund outright.

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

The notes priced on April 15 and will settle on April 20.

The Cusip number is 90276BYJ6.

The fee is 0.25%.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.