The best performing product in Canada in January 2019 was linked to the iShares S&P/TSX Capped REIT Index ETF. This is the TD XRE ETF-Linked Auto-callable Notes Series 122 issued by Toronto Dominion Bank. The product is a five year Auto-call linked to the iShares ETF and pays a return of 14.25% after one year providing the underlying asset is at or above its starting level (source: www.structuredretailproducts.com). The product had a European capital protection barrier of 85%.
First auto-call reached
The first auto-call opportunity for this product was the first anniversary of the strike date on 22 January 2019. On that date the level of the underlying ETF was 4.9% higher than its strike level. Therefore the product called paying a return of 14.25% for an investment term of one year. The underlying ETF has a dividend yield of approximately 4.35% which combined with its capital growth gives an overall return for the year of 9.24% for direct investors in the iShares S&P/TSX Capped REIT Index ETF (excluding any charges).
This is an ideal scenario for an autocall product to perform well earning a very attractive yield and also outperforming the underlying asset directly. A low to moderate growth in the underlying asset such as was observed here means the product will call and pay out a significantly higher annualised return than investment in the underlying asset. Therefore investors' returns have not been capped by the fixed return nature of the autocall.
Standard autocalls accumulate an amount each year which “snowballs” i.e. increases at the same fixed amount for every year that the plan runs. For example a product paying a return of 7% if the autocall conditions were met in year one would offer a return of 14% if the product did not call in year one but went on to call on the second anniversary.
Well chosen kick-start
This product had a “kick-start” autocall schedule where the first autocall opportunity had a significantly higher annualized return than the following opportunities. The first autocall point was after one year and paid a return of 14.25%. On each subsequent anniversary the autocall amount increases by 5% i.e. the product would have paid 19.25% if it had been called on the second anniversary. The potential annualised return of the product at each kickout opportunity was 14.25%, 9.2%, 7.51% ,6.62% ,6.07%. This reducing schedule reflects the diminishing effect of the high first year return. For this particular product the high first return was particularly useful since the product did indeed call at the first opportunity.
In general calling at the first autocall point has the highest probability of all outcomes under forward looking scenarios and the highest frequency of outcomes under backtesting analysis. The kick-start approach aims to capitalise on this increased likelihood of payoff in the early years and offer the best returns early on in the autocall schedule.
The probabilities of outcomes for TD XRE ETF-Linked Auto-callable Notes Series 122 under risk neutral (pricing) forward looking analysis and back-tested analysis are shown below:
|Outcome ||Risk-neutral simulation ||10 year back-test |
|Barrier breached ||17.2% ||0% |
|Call at point 1 ||44.1% ||73.36% |
|Call at point 2 ||12.29% ||2.47% |
|Call at point 3 ||6.16% ||6.56% |
|Call at point 4 ||4.5% ||2.35% |
|Call at point 5 ||3.34% ||3.9% |
|No call occurs ||29.61% ||11.37% |
In conclusion we note that investors should be very happy with this choice of product as a high return was earned in one year and the product comfortably outperformed a direct investment in the underlying ETF.