Scotia’s $3.12 million autocall market-linked step-up notes on Clean Energy ETF pose risks

By Emma Trincal

New York, May 18 – Bank of Nova Scotia’s $3.12 million of 0% autocallable market-linked step-up notes due June 3, 2024 tied to the iShares Global Clean Energy exchange-traded fund give access to a theme-oriented strategy and offer relatively good terms, advisers said. But they were cautious about the underlying, which they found overly volatile and concentrated.

The notes will be called at par of $10 plus a premium of 11.8% per year if the ETF's closing level is greater than or equal to the initial level on either of two annual observation dates, according to a 424B2 filing with the Securities and Exchange Commission.

If the basket finishes above the step-up value, 135% of the initial value, the payout at maturity will be par plus the ETF return.

If the ETF return is zero or positive but finishes at or below the step-up value, the payout will be par plus the step-up payment of 35%.

Investors will be exposed to any decline of the basket.

Sector specific

Steven Foldes, vice-chairman of Evensky & Katz / Foldes Financial Wealth Management, said he liked some of the terms.

“The 11.8% call premium is very nice. The fact that it’s cumulative is very nice,” he said.

But he brought up two main concerns.

The first one was generic.

“We typically do not buy notes based on sectors or segments, especially segments as narrow as global clean energy,” he said.

Big moves

“More specifically, the challenge is we’re investing in a very volatile ETF.”

The ETF rose 138% last year, following a 38% growth in 2019. But since its Jan. 8 52-week high, the fund has dropped 36% this year.

“Even though it’s down significantly for the year to date, it had two very big years in a row. It could drop significantly, in which case you may not be able to recover in time. In that instance you could finish below the offering price and not get the benefit of the handsome premium.”

“When you’re talking about a broadly diversified index, usually three years is enough of recovery time. But that’s not necessarily the case with a particular sector.

“For those two reasons, the narrow universe of the ETF and its volatility, we would stay away from the notes.

“If it was on a broader index, it would be much more attractive. Naturally the premium would also be lower.”

Snowball

A financial adviser said he liked most of the terms of the note but was not comfortable with the underlying whose components were not well-known blue chips.

“I like the issuer. Canadian banks usually have good credit ratings,” he said.

“The 2% fee looks reasonable although if you get called at the end of year one, that’s expensive. The fee could be high, it could be average. I couldn’t tell. It depends on the call.

“I also like the call premium setup. It’s a snowball. I like that structure.”

So-called “snowball” autocallable notes pay a cumulative call premium upon the occurrence of the call.

The advantage of this payout, he said, was that investors missing the call on the first year may “catch up” on the second without losing any premium. At maturity, the step-up payout is roughly the equivalent of a cumulated premium for three years.

Concentration

“The hardest part is to get your arms around the ETF itself,” he said.

“Also, this is a fairly concentrated ETF.”

The weighting for the top 10 holdings is half of the portfolio out of a total of 85 stocks.

In addition, the ETF has a greater exposure to non-U.S. countries with 63% of the fund.

Top component Vestas Wind Systems is a Danish manufacturer of wind turbines.

Orsted, the second largest holding, is another Danish company, which develops offshore wind power.

Iberdrola, the third largest position, is a Spanish multinational electric utility company.

Those top three companies make for 20% of the fund.

“The high concentration in international stocks is not necessarily a bad thing. But a lot of their performance is going to be dictated by politics, which is a wildcard. Meanwhile the current administration here in the U.S. is going to give you a lot of support for clean energy,” he said.

Trading patterns

This adviser likes to show his clients well-known names in well-recognized benchmarks.

“If you know the companies in the ETF, it makes it a lot easier to give some confidence to the client,” he said.

“I don’t know most of those companies except Xcel Energy.”

This would make the tracking of the fund’s performance more difficult for the adviser, he noted.

“This is an index that has not moved in line with the S&P at all.

“It doesn’t trade based on the fundamentals. A year ago, it was at $10. If these things don’t put up profit, you go back to $10.”

He noted that the ETF price has strongly declined this year. But he would not be able to tell if the current price offered a good entry level.

“It went straight up last year and dropped this year, even though we have a favorable political environment.

“It’s hard to say why. Before 2020 it was not a volatile index. Then it began to surge. You would expect this to trade more in line with utilities. But it doesn’t.

“I would take this index with a big grain of salt,” he said.

Protection

The advantage of the structure was the two call premium giving investors a chance to cumulate a high return.

“I often complain about the caps and coupon rates of structured notes. But 11.8% is fair. It compensates you for taking on equity risk.

“You’re likely to get called out on year one. However, if you don’t get called, you don’t have any downside protection. That’s an issue too.”

BofA Securities, Inc. is the underwriter.

The notes will settle on Thursday.

The Cusip number is 06417V311.

© 2015 Prospect News.
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