Product review: UBS offers growth from inflation

An unusually long tenor for a US structured product is one prominent feature of UBS’s Contingent Real-Return Performance Securities. Based on the S&P 500 and a US Consumer Price Index, returns are uncapped, although capital is not protected is the S&P 500 falls by 40%

This is a five-year growth product linked to the performance of the S&P 500 index and the non-seasonally adjusted US City Average All Items Consumer Price Index for All Urban Consumers (CPI). At the end of the product term, investors will receive returns equal to the growth in the best-performing index. Capital is not protected if either final index level is 50% or more below its initial level at maturity.

The product will pay returns equal to the best performing underlying provided the barrier is not breached. If both the S&P 500 and CPI are higher than their initial levels at maturity then the growth of both indexes over the five-year term is calculated and investors receive returns equal to the best performer with no cap on returns. If the S&P 500 index is between 60-100% of its initial level at maturity, investors will receive returns equal to the growth in the CPI. For example, if the final level of the S&P 500 is 10% higher than its initial level and CPI has risen 12% over the five-year term, investors would receive a return of 12% at maturity.

Capital repayment is linked to the performance of the S&P 500 index alone. If the final level of the index is less than 60% of its initial, capital will be lost at a rate of one percentage point for every percentage point fall in the index. Using our usual index distribution assumptions, we have calculated that the probability of hitting the barrier is 7%. If the barrier is breached investors would receive less than 50% of their initial investment.

It is worth highlighting that this is not an American-style 60% barrier, which if breached during the term of the product places the investor's capital at risk - the amount of which is dependent on the final level of the index (European-style option). By including a 60% final day barrier - also known as a trigger - this product allows for any index change during its lifespan without it affecting whether full capital is returned to investors at maturity. Instead, risk to capital is based on whether the final index level remains within the 60% barrier. If it is equal to or lower than the 60% final day barrier then the amount of capital returned is calculated using the final level of the index.

This product would appeal to investors who want to benefit from growth in the S&P 500 while also hedging against inflation. As long as the index is above the 60% barrier at maturity, investors will receive at least the growth in CPI, which as an indication of inflation should protect the real purchasing power of the investment.

Pricing and risk

The downside is linked only to the performance of the S&P 500 and is simply a put with a strike of 100%, gearing of 100% and a European barrier at 60%. The upside is more complex because the payout depends on the performance of the two indexes, meaning correlation between the S&P 500 and CPI must be taken into account.

Multi-asset products are usually regarded as being riskier than single-asset or basket products, but this only applies if the payment of returns or repayment of capital is dependent on both assets. This product is closer in profile to a capital-at-risk S&P 500-linked growth product with a contingent minimum return, though in this case the minimum return is CPI growth rather than a fixed payment. The minimum return or CPI growth is paid as long as the S&P 500 does not finish more than 40% below its initial level. Although the risk associated with this product is not adversely affected by its multi-asset nature, the complexity of the payout is higher than would be the case with a single-asset product.

In addition to the market risk, the product also involves the credit risk of the issuer, UBS. While five years is not particularly long for products in most markets, shorter maturity growth products of between one and two years are more common in the US, so investors should be aware of the additional risk associated with a longer dated product.

 

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The information in this analysis is taken from sources which Future Value Consultants Limited deems reliable but no guarantee is made that the information is complete or accurate and it should not be relied upon as such. Any opinions in the analyses represent those of Future Value Consultants Limited at the time of writing but are subject to change. All valuations and prices shown are indicative only and do not imply an offer or commitment of any kind. The analysis does not constitute advice or recommendations nor should it be relied upon for any purpose. No liability whatsoever is accepted by Future Value Consultants Limited or Structured Products magazine for any loss or expense incurred from using this analysis.