UBS’ buffered notes on SPDR S&P Biotech show adequate entry, terms, but risk lies with tenor

By Emma Trincal

New York, July 8 – UBS AG, London Branch’s $100,000 of buffered return optimization securities due July 5, 2024 linked to the SPDR S&P Biotech exchange-traded fund presented relatively attractive terms, but the two-year maturity was a concern, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

If the ETF closes at or above its initial price, the payout at maturity will be par plus two times any gain, capped at par plus 48.3%, according to a 424B2 filing with the Securities and Exchange Commission.

If the ETF declines by up to 10%, the payout will be par. Investors will be exposed to any losses beyond 10%.

“The terms of this note are not bad. But the price is not as good as it was a couple of months ago. My main concern is the two-year period given where the market is right now,” he said.

One positive aspect of the notes for this contrarian investor was the choice of the ETF itself.

Recent rebound

“This is a well-known biotech fund that’s unpopular because its price dropped significantly. When something drops so much, people assume there’s something wrong with the stock. The more the price drops, the more people sell,” he said.

From its September high at $136.61, the fund’s price plummeted to $61.78 in May, a 55% drop in eight months.

“It had two consecutive lows in May and also in June. But since then, the price has gone up by more than a third. I wouldn’t buy it today,” he said.

The ETF closed at $84.43 on Friday.

However, when the notes priced on July 1, the closing price was $76.54.

“That’s not terrible. In fact, it’s still a reasonable price. Not the bargain price of 62 in May or June, but at least, it’s in the general ballpark,” he said.

The right time

Kaplan said he is familiar with the ETF for having purchased its shares recently when the fund was at a low point.

“Below 70, it was a good bargain,” he said.

At the time, the price-per-earnings ratio was below 8. On Friday, the P/E was at 11.25.

When the fund was trading below 70, insiders were heavy buyers of the ETF, a positive signal for this portfolio manager.

“I did some research back in May and June and found out that biotech was the sector with the heaviest insider buying. Today insiders are still buying but at a much slower pace. However, they’re not selling yet. The price is not high enough to drive them to sell,” he said.

Diversified fund

Unlike many ETFs, the underlying fund offered a high level of diversification, he said.

The ETF has 157 holdings. The top one has a weight of only 1.67%, a sharp contrast with Apple and Microsoft, which respectively make for 7% and 6% of the SPDR S&P 500 ETF.

The Invesco QQQ fund, which replicates the Nasdaq-100 index, is also “poorly diversified,” he noted, with the top 10 holdings accounting for 52% of the portfolio.

Good structure

The terms of the notes were relatively attractive, said Kaplan.

“The 48.3% cap is fairly generous. I also like that it’s a buffer and not a barrier. You could end up below 10% but you do have a little bit of protection for sure,” he said.

“If you happen to have a loss at the end, you can always buy the fund at the depressed level. That way if the note doesn’t work out at maturity, you’ll take advantage of a bargain.

“I like the cap. I like the buffer. I also like the leverage.”

What Kaplan did not like was the length of the trade.

“I wouldn’t do a two-year. We’ve started the process of a decline in asset valuations at the beginning of the year. More people are beginning to accept that we are in a bear market. 2024 is probably not going to be a good time for the notes to mature,” he said.

He explained why.

“Historically, the two or three years following the beginning of a bear market tend to be the low point.”

After the October 1929 crash, the Dow Jones industrial average hit its lowest point on July 1932, posting an 89.2% loss in less than three years.

The Nasdaq lost more than 80% from its peak in early 2000 to the end of 2002.

“If this bear market follows the same historical patterns, 2024 will probably be one of the lower points, whether the lowest, we don’t know, but the two-year timeframe is far from ideal in this context,” he said.

“I would much rather have a one-year or even a four- to five-year tenor. Either way, we probably won’t fall into the depth of the bottom. But two years is a tough period.”

Furthermore, the notes will mature four months ahead of the 2024 Presidential Elections.

“It’s definitely a volatility factor. If on top of it we’re in a recession in the months leading to the Elections, volatility is likely to climb even more, a little bit like in 2008 when the market had to digest a recession and a Presidential Election at the same time. This is the kind of situation where the market does very poorly,” he said.

In conclusion. while the entry price and the structure were “reasonable,” Kaplan would not consider the notes.

“Perhaps it would work better if you had one-to-one on the upside with a much bigger buffer on the downside,” he said.

“Still...The problem is the timing.”

The agent is UBS Financial Services Inc. and UBS Investment Bank.

The notes settled on Wednesday.

The Cusip number is 90303U363.

The fee is 1%.

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