UBS' five-year trigger performance notes linked to S&P 500 add value to long-term bullish play

By Emma Trincal

New York, June 1 - UBS AG, London Branch's 0% trigger performance securities due June 30, 2017 linked to the S&P 500 index are designed for long-term bulls seeking an attractive risk/reward profile, said structured products analyst Gurdeep Ubhi with Future Value Consultants.

The structure offers a protective barrier level against downside risk, a leveraged return on the upside and no limitation on the gains, he said, adding that all those features make for an attractive investment in a high-growth scenario.

However, investors have to be willing to hold their securities for a relatively long period of time.

If the index return is positive, the payout at maturity will be par plus 1.45 to 1.55 times the index return. The exact leverage factor will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

If the index return is zero or negative and the final index level is greater than or equal to the trigger level, 50% of the initial level, the payout will be par.

If the final index level is less than the trigger level, the payout will be par plus the index return, with full exposure to losses.

Terms

"You don't see a deep barrier at 50% that often. It's not unusual in the U.K., but it's less common in the U.S.," Ubhi said.

"The duration is also unusual; most of U.S. products have a one- to three-year tenor unless you're talking about full principal protection.

"A five-year fully protected note would be rare. You could get it but probably with a lower participation rate and it would be capped.

"The fact that investors are taking some risk, even if it's half-way protected, enabled the issuer to offer the leveraged and uncapped upside."

The most likely buyers of the notes, Ubhi said, would be a bullish investor with a mid-term to long-term outlook.

"The fact that you're still taking some risk and that you're willing to be locked in for five years show that you have a positive outlook on the market. The absence of any limit on the upside makes this product especially appealing to long-term bullish investors," he said.

Riskmap

Despite the protective barrier, risk is a key aspect of the structure, he added, pointing to the riskmap, a Future Value Consultants rating that measures the risk associated with a product on a scale of zero to 10. The higher the riskmap, the higher the risk of the product.

At 4.67, the notes have a higher riskmap than similar products, which have an average 4.25 riskmap, according to the research firm's report.

In this case, the "similar product" or "same product type" category is all leveraged notes regardless of their tenor and whether they feature downside protection or not.

"Despite the low barrier, if the index is down 50%, you lose 50%. It's not a buffer, and many other leveraged products are buffered. With this one, your entire principal is at risk when the barrier is breached," he said.

However, most of the risk for this product is derived from credit rather than market risk, he noted.

"We break the riskmap into two things: the market riskmap and the credit riskmap," he said.

The market riskmap for the notes is only 3.23 on the zero to 10 scale. It is less than the average market risk for the same category of leveraged products (3.28). It is also lower than 3.54, the average score for all products.

"It's because the barrier is lower than a lot of products," Ubhi said.

"Also, the S&P 500 is less volatile than other indexes or even stocks, which you may also find in these types of products.

"In addition to that, it's a final-day barrier, which allows the index to go anywhere during the term as long as it doesn't end up more than half way lower."

But the credit riskmap for the notes, 1.45, is greater than the 0.98 average for the same product type and the 0.71 average for the all-product category.

"The elevated credit risk comes from the longer duration. You're taking the issuer's credit risk, but most importantly, you're taking it for five years. This is why it's so high," he said.

Value, return

Overall though, the product offers good value as reflected by its return score, said Ubhi.

The return score is Future Value Consultants' opinion of the risk-adjusted return calculated from five key assumptions: neutral assumption, high- and low-growth environments and high- and low-volatility environments. The research firm calculates a risk-adjusted average return for each assumption. The return score is the best of these five returns.

With this product, the optimal scenario is "high growth," he said, since the upside is unlimited.

The notes show an 8.70 return score, compared with 7.15 for similar structures and 6.48 for the average of all products, the report shows.

"It's high because of a combination of very good features: the 50% barrier, the uncapped and leveraged upside and the fact that the underlying is not overly volatile," he said.

"Anytime you have uncapped returns in a high-growth market environment, you're going to have a high return score."

With its probability chart, Future Value Consultants estimates how the product is expected to perform under the five key assumptions. It assigns a probability of return outcome each of the payoff buckets.

The chart is generated using a Monte Carlo simulation using various parameters such as volatility, dividends and interest rates.

Based on the high-growth assumption, investors have a roughly 90% chance of generating a positive return against a 10% probability of losing money. However, the amount of losses would be significant, exceeding 50% of the initial investment.

On the positive side, the chance of generating an annualized return in excess of 15% is relatively high at 26%.

Price, overall

Future Value Consultants measures with its price score on a scale of zero to 10 the market value of the underlying components of the product. The higher the score, the lower the fees and the greater value offered to the investor.

The price score for the product is 8.30, which is better than 7.34, the average score for similar products, Ubhi noted.

"It just shows that the issuer spent some decent amount of money on the options," he said. "As a result, investors receive value."

The price score and return score are averaged to obtain the overall score of the product, which represents Future Value Consultants' opinion on the quality of a deal.

With an overall score of 8.50, this product is much more attractive than its peers, which have an average 7.25 overall score. It is also better than the average for all products at 6.72, he said.

"It's a good deal. It's uncapped. It has a deep barrier. It's five years, so the bullish investor gets unlimited returns over a decent amount of time," he said.

"If you're a bull with a relatively long-term horizon, if you anticipate growth over time, this is a decent product."

The notes (Cusip: 90268U317) are expected to price June 26 and settle June 29.

UBS Financial Services Inc. and UBS Investment Bank will be the underwriters.

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