Issuers take advantage of trends; UBS launches coal-linked autocallables; Barclays links to inflation index

By Kenneth Lim

Boston, July 10 - UBS AG's new coal-linked autocallable notes and Barclays Bank plc's notes linked to an inflation momentum switching index take advantage of recent trends in their underlying sectors, an investment adviser said.

UBS links to coal

UBS plans to price a series of zero-coupon autocallable optimization securities with contingent protection due Jan. 29, 2010 linked to a basket of coal stocks.

The basket includes equal weights of Peabody Energy Corp., Consol Energy, International Coal Group Inc. and James River Coal Co.

The notes will be automatically called if any of the basket stocks closes at or above its initial level on any of six quarterly observation dates. If the notes are called, the redemption amount will be par of $10 plus an annualized call return of 24% to 27%. The exact return will be set at pricing.

If the notes are not called, the payout at maturity will be par unless any basket stock closes below the trigger level of 60% of the initial level during the life of the notes and finishes below the initial level, in which case investors will be fully exposed to the basket decline.

Coal volatility up

The UBS notes arrive just as volatility in the coal sector increased earlier in the month as coal prices fell. Peabody's common stock is down about 16% from its end-June level, while Consol is down about 18%, International Coal by about 23% and James River by about 26%.

"There's a segment of the market that definitely thinks there's a bubble in commodities," the adviser said. "So it's not surprising that there's some profit taking every now and then. But energy commodities like coal aren't really like other commodities like grains or metals. You're always looking at oil prices, which don't look like they're going down long term. Prices went down a little last week, but they're bouncing back so the sector could still go up. If you think that way, given where the stocks went last week, you might want to consider something like this."

Just a neutral view of the sector might not be enough for the note to make sense, the adviser said.

"You really want the basket to go up with a structure like this," the adviser said. "If your view is that it's just going to be up by about 1% after three months, when you take into account the volatility there's a risk that on the observation date you might not get the call because the basket just happens to be down."

"But even if you don't think there's a bubble or you don't think the stock's not going to correct that much more, you still need the stocks to go up," the adviser said.

Linking the payout to a basket should make the product less volatile than just linking to one coal stock, but the difference may not be significant, the adviser said.

"Usually when you link to a basket or an index, that tends to be less volatile than a single stock," the adviser said. "But the correlation between coal stocks I would imagine is pretty high just because it follows coal prices so closely, so it might be less volatile, but not by that much."

Barclays links to inflation index

Barclays plans to price zero-coupon principal protected notes due July 30, 2013 linked to its new algorithmic inflation momentum switching (AIMS) index.

If the final index level is greater than the initial level, the payout at maturity will be par of $1,000 plus double the index return. If the final index level is less than the initial level, investors will receive par.

The index, which was launched on June 12, seeks to reflect the excess returns available by taking a long or short position in inflation-protected securities issued by the U.S. Treasury based on trends in current and expected U.S. inflation. At any given time, the index has either a short position or a long position in the Barclays U.S. Government Inflation-Linked Bond index. It is rebalanced each month.

The decision as to whether to take a short position or a long position in the index for the next month is made based on a trading signal: If the trading signal indicates that either current or expected inflation is flat or increasing, the index takes a long position in the bond index; otherwise, the index takes a short position in the bond index.

"The AIMS index is designed to capture performance by switching between long and short TIPS exposures based on the perception of inflation concerns in the market," Barclays said in a statement on the index. "The rationale underlying the strategy is that market participants switch from nominal bonds to TIPS when concerned about inflation. As the nominal bond market is a substantial multiple of the TIPS market, the switching results in an exaggerated demand for, or supply of, TIPS and this in turn leads to strong price pressures."

"In today's environment of mixed inflationary and deflationary fears, strategies that extract value without strong adherence to a view have particular appeal to investors," Barclays head of U.S. rates client solutions said in the statement. "Barclays Capital is leveraging its position as a leading inflation house to bring the first algorithmic inflation index product to market."

Barclays index addresses uncertainty

The Barclays product offers investors a way to ride out periods of uncertainty regarding inflation, the adviser said.

"This looks like it benefits from changes in inflation protected treasuries," the adviser said. "When people think inflation is going to go up or down, that will lead to changes in the prices of these Treasuries. But these prices only change significantly when there's uncertainty. If the view is inflation is going to be the same, there won't be as much demand for the inflation-protected Treasuries. So in a, I guess you would say, a calm economy, this might not work as well."

© 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.