Wells Fargo to offer defensive autocalls tied to Energy Select SPDR for mild bulls

By Emma Trincal

New York, June 29 – Wells Fargo & Co.’s market-linked securities due July 6, 2021 – autocallable with fixed percentage buffered downside linked to the Energy Select Sector SPDR fund give investors a chance to collect a premium in a moderately bullish market, sources said. Unlike most autocalls, this one comes with a buffer, giving the structure a more conservative edge, they noted.

The notes will be called at par plus an annual call premium of 7.5% to 8.5% if the fund closes at or above its initial level on any annual review date, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par unless the fund falls by more than 10%, in which case the payout will be par plus the return of the worst performing index with exposure to any losses beyond 10%.

Memory

“The structure is not bad. At least you get a reasonable return and a reasonable downside protection,” said Steven Jon Kaplan, founder and portfolio manager of TrueContrarian Investments.

The “memory” feature of the payout, which enables investor to “catch up” with unpaid past premium once the automatic call is triggered, was also beneficial.

For instance, a call occurring on the second call date would yield a 16% premium; on the final observation, investors can get 24% in positive return, based on the midpoint of the call premium range.

Chasing the rally

But Kaplan, who is a contrarian, had some reservations about the underlying valuations.

“The structure is not bad. But I’m afraid the Energy Select is a little rich at this time,” he said.

“Its most heavily weighted stocks are not nearly as closely related to energy prices as what you’ll find in other energy ETFs.”

He cited the VanEck Vectors Oil Services ETF as an example of a more energy price-sensitive fund. Its top components include service firms Schlumberger Ltd. and Halliburton Co.

“The problem with the Energy Select is that it tends to pick the very biggest companies that are connected to the energy sector. But in reality, they’re also very correlated to the S&P,” he added.

Exxon Mobil Corp., the top holding of the underlying ETF has a weighting of nearly 23% in the Energy Select.

“The S&P is extremely popular. There is more downside risk to the S&P than there is in the energy sector,” he said.

Energy stocks have rallied since last summer when they bottomed, he said. But it does not compare with the resilient bull market seen in the broader U.S. market, which has pushed prices to records for nearly a decade.

“I bought the Select Sector in August when it was very unpopular and I sold in January as people began to buy it a lot. The rise in crude prices has made this rally a very crowded trade.”

The ETF share price closed at $75.36 on Thursday. From its low in August at $62.00, the price has jumped 21.5%.

S&P 500 correlated

But Kaplan was more concerned about the fund’s high correlation with equities as a whole.

“Even though energy is up, it’s still way below its all-time highs of 10 years ago.

“It’s unfortunate that they would come up with these notes after such a significant increase in the price. I noticed notes usually come out after a solid rally. It’s a popular theme so they come up with something.

“But you have to look at the price. Anytime an asset goes up a lot you have substantial downside risk. It’s good to have a 10% buffer but it’s probably not enough,” he said.

“You want to participate when the price is low and the underlying unpopular, which is what was going on last summer.”

Participation preferred

Jonathan Tiemann, president of Tiemann Investment Advisors, said he would not consider the notes because he prefers participating in the upside rather than receiving an “unpredictable” call premium.

“You can’t be too bullish because you’ll miss the upside. It’s got to move up just a little bit. It’s kind of dull.

“I guess you really have to have a very narrow outlook. Flat or up just a little.

“Personally, I’d rather have participation or not. If I want it, I buy it. If I don’t, I don’t participate,” he said.

Tiemann conceded that the buffer was efficient in reducing risk. But it was not enough to win him over.

“It’s not a very risky instrument. That’s not the problem. There’s just too much uncertainty in terms of what the final payout is going to be for me to consider it.

“You don’t know if you’re going to hold the notes for one year, two years or three years,” he said.

Not income

Tiemann agreed that the cap allowed the issuer to provide value with the buffer.

This type of risk-reward can also be found in a leveraged capped note. Investors usually choose between participation and income. But the autocall structure offered in this note offers none of those two payout types.

“I would prefer a note that pays a regular coupon even if it’s not a fixed rate. At least you can get some income.”

Wells Fargo Securities LLC is the agent.

The notes will settle on July 5.

The Cusip number is 95001B4C5.

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