Bank of Montreal to price autocallables linked to rarely used Market Vectors Russia ETF

By Emma Trincal

New York, May 22 - Bank of Montreal plans to price 0% autocallable cash-settled notes with step-up call price due May 31, 2016 linked to the Market Vectors Russia exchange-traded fund in an effort to offer investors a contrarian play amid the geopolitical tensions between Russia and Ukraine, sources said.

It is the first time the underlying ETF has been used in a structured note in three years, according to data compiled by Prospect News.

Bank of America Corp. was the last issuer to structure a product linked to the Market Vectors Russia ETF. It was in April 2011 with Bank of America's $3.83 million of 0% Strategic Accelerated Redemption Securities due April 27, 2012, according to the data.

Akin to the old deal, the upcoming Bank of Montreal offering is an autocallable.

If the fund's level is greater than the initial level on any quarterly call date, the notes will be called. The call return will be 10% per year, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called, the payout at maturity will be par if the fund falls by up to 25%. Investors will share in losses from the initial level if the final price is less than the 75% trigger level.

Sources said that for risk-takers, allocating money to Russia may be seen as a value investment or contrarian bet, which may be timely. But by capping the upside, the autocallable structure could defeat the purpose of the strategy.

Autocallable

A market participant said the upside risk is his main concern.

"Personally, I do like the idea of investing in Russia. I do think that at some point, the Russian market is likely to rebound. While there's a crisis in Ukraine I don't think Russia really wants to make matters worse. So yes, I think the asset class is likely to go up in two years," this market participant said.

"However, I am not crazy about the idea of a 10% return for the risk I'm taking. Because even if the odds of a market collapse two years from now are slim, it's still a risk. You never know. If things go wrong, they will go really wrong given the volatility of this market. So while a major crash is unlikely to happen, the losses could be substantial if it did happen."

Too little too soon

The autocallable structure is even less appealing in the event of an early call, he added.

"If you're called at the end of the first quarter, you only get 2.5%. It doesn't seem like it's enough to compensate me for the risk," he said.

Less frequent observation dates would have been preferable, he added.

"Having the first observation after six months to get at least 5% would have been better. I know that 10% per year is 10% per year, but from a risk-reward standpoint, I don't see the 2.5% return as very attractive.

"You have a high probability of a nice coupon, but it could very well be a fairly small coupon.

"If a negative event materializes, if things deteriorate, you could be on the hook and see the fund easily go down by more than 25% at the end. It's a risky trade.

"What doesn't work here is the limited upside. If I take the downside risk from Russia, I'd like to have some upside and probably in the form of uncapped or higher capped participation."

Volatile, 'unloved'

Steven Foldes, president and chief executive of Foldes Financial Management LLC, agrees.

"This ETF is based on a very volatile index. If you're buying this, this unloved asset class, it's because you're looking to bring some juice in your portfolio. You believe in the upside potential of this market, otherwise you wouldn't expose yourself to such high level of risk. So why would you want to cap yourself at 10% a year?" he said.

In 2008, the fund was down 73%. "It was a disaster," he said. The following year, the ETF surged by 139%, a move he called "an explosion." As of the end of April, the ETF was down 21.34% for the year. It has been up 12% since then.

High risk, limited reward

"Why would you want exposure to such a volatile asset class? Especially with the type of downside protection being offered," he said.

"If you're not called, your protection at maturity is only contingent. It's a barrier. If anything, this type of structure calls for a buffer, not a barrier. This is so volatile you could very easily breach the barrier and then find yourself with no protection whatsoever. If you crash through the barrier, you are in serious trouble. This is something I would have no interest in."

Given the downside risk, the notes should offer a higher return potential, he said.

"There is a logic behind that trade. It's absolutely contrarian," he noted.

"If you believe in this market, this may not be a bad entry because it's down so much. But that's the point: if you are buying it because you're contrarian, you want to run up with the price. With this type of risk, I want all the room to run that I can possibly get."

The notes (Cusip: 06366RUE3) are expected to price Friday and settle May 30.

BMO Capital Markets Corp. is the agent.

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