Investment Road Test: UBS Market Growth Instalments

A low-cost investment alternative without significant exposure to a market downturn.

PORTFOLIO POINT: This style of instalment can be useful to investors wanting to reduce their risk of loss in the event of a market fall.

Consumer research is about to show a dramatic uptick in Australian investor confidence – with negative sentiment remaining but moving closely up to the levels of cautious optimism.

Investors are also starting to nominate that they are looking for investments which are suitable for a “post cash” environment – but still with an emphasis on minimising risk and preserving wealth. In these scenarios it is often feasible to consider leverage as a way to minimise outlay at the same time as accessing desired investments, including Australian shares.

UBS has recently launched a range of ASX-listed “Market Growth Instalment” warrants that offer 100% finance, with a limited recourse security structure, and with a capped upside (which translates into a lower cost for the overall finance package).

The Market Link Instalments are available over a wide range of ASX blue-chip stocks. A full list is available at the UBS website. As usual, these instalments can be purchased direct from the issuer (by completing the application form in the PDS) or through the secondary market, via the broker of your choice. So for an investor that expects the ASX to gain in value over the next 12 months, but who wishes to reduce the risk of loss in the event that markets fall during the period, these style of instalments can be a valuable investment tool.

The Market Link Instalments use a standard instalment warrant structure. Shares are held in a security/custody trust account pending the eventual repayment of the loan which is granted at the inception of the product, and which is used to fund the initial purchase of the shares. Because the loan covers 100% of the initial cost of the shares, the initial outlay or “First Instalment” simply represents the cost of interest associated with the loan. The cost of the protection which UBS creates (to allow it to advance 100% of the cost of the share) is also bundled into the interest rate. To reduce the effective cost of the loan, the shares have their upside performance capped, either at 115% of the starting price (for the “SSE” series) or 120% of the starting price (for the “SSF” series). In practice this means that the investor does not participate in any upside above the capped levels – which will not be a material detraction unless and until the share price rises by 15% or 20% from its starting level. Of course, an investor who experiences growth of this sort will no doubt be extremely pleased to do so – even if their performance is capped beyond those levels.

The Market Growth Instalments initially listed on the ASX on 26 June 2012, so investors need to reference their finance and protection levels, as well as cap levels, to the prevailing prices on that date. That is, if the shares have risen since that date, an additional amount will need to be contributed by the investor to supplement the finance (set at 100% of the prevailing level on the product start date); and the cap level will be closer compared to the level prevailing on the product start date).

One of the strong benefits of the Market Growth Instalments is the creative use of “hard” put options to create the protection within the product. Unlike some of the other forms of capital protection which investors may have experienced, put options provide certainty of outcome – but they are relatively expensive compared to other less robust forms of protection. To minimize the overall expense, UBS has embedded put style protection in the Market Growth Instalments set at 90% of the prevailing share price – and supplements the actual loan within the product be lending an amount on account of the expected next year’s dividend to the investor. In return, as dividends are paid on the shares during the next 12 months, they are mandatorily re-invested to repay the loan within the instalment (including the “top up” amount).

This innovative mechanism allows UBS to offer interest rates (which includes the cost of protection) at all up costs which are often below 10% pa, or which may (depending which stock is selected) not far above that range.

Because the Market Growth Instalments hold physical shares, the investor receives actual cash dividends and franking credits arising from those dividends. As noted above, the cash dividends are mandatorily applied to reduce the loan amount, but the franking credits will be passed through to the end investor. Tax deductions for the cost of interest will be available (noting the limit on immediate deductibility which is linked to the RBA Home Loan Mortgage rate 1% pa).

There is an interesting problem for investors seeking to access franking credits on share dividends where the overall investment risk is modified. The ATO introduced the “delta” rule in 1997 to require that investors need to retain 30% of the risk/reward profile of a share for the first 45 days a share is held (around the first dividend paid during that period), in order to be able to claim the franking credits on the dividend. The “at risk” rule uses the “delta” of the combined share/option position to measure the existence of the required 30% minimum risk/reward. “Delta” is an exotic concept which most investors won’t be capable of measuring – so you will need to check with your broker or UBS to understand the implication of this rule to your specific circumstances. The PDS for the Market Growth Instalments states that the 115% capped series (“SSF”) may not always satisfy the 30% “at risk” rule – so be sure to check this prior to investing.

Apart from the interest cost, the only additional fee payable would be the (up to) 2.2% fee if an adviser is used to manage the investment. Direct investors won’t need to pay this cost. At the end of each year, the instalment can be rolled over – with interest for the following year being capitalised against the underlying share position.

The UBS Market Growth Instalments offer a clean and relatively low cost way to enter the ASX share market without exposing significant amounts of capital to the risk of a market downturn. At the same time, the Market Growth Instalments offer the potential to deliver just that – the potential for growth, if our markets continue to improve.

The score: Covered Call Options – 4 stars

1.0        Ease of understanding/transparency

0.5        Fees

1.0        Performance/durability/volatility/relevance of underlying asset

1.0        Regulatory profile/risks

0.5        Innovation

(The scorecard relates to the “delta” strategy in the ASX research paper)


Tony Rumble is the founder of the ASX-listed products course LPAC Online. He provides consulting and financial product services but does not receive any benefit in relation to the product reviewed.

Related Articles