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Potential Outcomes for an Autocallable Note
What used to be reserved only for institutional and high net-worth individuals is now more readily available than ever. Several new autocallable ETFs, like TrueShares S&P Autocallable Income ETFs, are now on the market and intriguing investors with their potential.
These autocallable ETFs are based on the performance of a reference index over a set term period, with clearly defined parameters designed to provide stable, high monthly income if those parameters are met. It’s all about thresholds, barriers, triggers, and coupons, all of which are set from the inclusion of an autocallable in a portfolio. To better understand what might happen in different market scenarios, we’ve broken the concept down into several potential scenarios for a single autocallable.
To refresh yourself on the terms, see What are Autocallables.
Let’s consider a 3-year autocallable, with a non-callable period of one month, coupon of 9%, annualized (fixed income component), a coupon threshold of 80% of the value of the reference index, and a principal barrier of 50% of the value of the reference index.
At the end of 2 months (the next observation date after the non-call period), there are 3 potential scenarios that could take place with the autocallable (see above):
- If the reference index is 100% of its initial value or more, the autocall trigger has been breached for that autocallable and the autocallable is called. The investor receives their full principal back, plus the coupon payment for that observation period.
- If the reference index is between 80-100% of its initial value, the investor receives their coupon payment for that observation period and the autocallable continues.
- If the reference index is less than 80% of its initial value, the coupon barrier has been breached and the fund does not receive the coupon payment for that observation period, but the autocallable continues.
At the end of 3 years (at maturity), assuming the autocall trigger has not been breached at any monthly observation date, there are 3 potential outcomes of that autocallable (see above):
- If the reference index is between 80-100% of its initial value, the investor is repaid the entirety of their principal and still receives the final coupon payment for the last observation period. The investor still receives their coupon payment because it has not fallen enough to breach the coupon threshold of 80%.
- If the reference index is less than 80% of its initial value, the investor is repaid the entirety of their principal, but does not receive a coupon payment for that observation period. The investor receives their principal because the value of the reference index is above the principal barrier of 50%, but the investor does not receive their coupon payment because the value of the reference index has fallen enough to breach the coupon threshold of 80%.
- If the reference index is 50% or less of its initial value, the investor receives a reduced principal repayment and does not receive a coupon payment for that observation period. For example, if the reference index is 40% of its initial value, then 40% of the initial principal will be repaid.
All autocallables expose the principal investment to market losses if the reference index falls below the principal barrier at maturity. Now consider a principal barrier of 60% of the reference index, meaning the value of the reference index would have to drop 40% below its initial value for the investor to start losing any of their principal investment.
How often has the market, historically, dropped 40%? Only 5.83% of the time in the last two decades.
In the vast majority of markets (historically), principal investments in an autocallable product are preserved. An ETF of autocallables smooths the ride even more than a single autocallable by combining multiple autocallables into a single portfolio. Even if one autocallable falls below the coupon threshold or principal barrier, the other autocallables are there to level out the portfolio, potentially providing even more downside protection. Autocallable ETFs focus on providing stable income and returning the principal, even if that means the market is down.
TrueShares offers two new autocallable ETFs, the S&P Autocallable High Income ETF (PAYH) and the S&P Autocallable Defensive Income ETF (PAYM). PAYH and PAYM bring the popular autocallable income strategy to investors seeking high, stable monthly income. The ETF wrapper seeks to offer predictable income, contingent protection, and built-in hedging, all in a tax efficient single-ticker solution.
To learn more about the funds, visit: https://www.true-shares.com/autocallable-income-etfs
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