UBS Markets Money-Making Alternative as Chinese Stocks Tank

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UBS Group AG, the world’s largest manager of money for the rich, is marketing structured notes tied to the performance of so-called Class A funds in China that can deliver returns if shares nosedive.

The notes, to be issued by a special purpose vehicle, will be comprised of onshore Class A funds that are trading at least 15 percent lower than their net asset value, according to two people familiar with the matter. The securities will pay a coupon 3 to 4 percent higher than China’s one-year fixed deposit rate regardless of the underlying assets’ performance, and can increase in value should the discount of the Class A funds narrow, the people said.

Some Chinese listed funds are split into Class A and Class B tranches, where the latter invests the capital received from Class A to generate returns, while Class A receives a fixed coupon. If more investors pile into Class B in the search for higher gains, Class A typically trades at a discount. The reversal of that divergence is one way investors can make money.

“In some cases, as has happened during the Chinese rally, the clamor for leveraged participation has led to the B class trading at a premium to its net asset value, pushing the A class to trade at a discount,” UBS said in a report last month. “This has raised the A class’s yield above the coupon, despite the lack of any fundamental deterioration in the economics.”

Shanghai Slump

The special purpose issuer will use the yuan qualified foreign institutional investors’ quota, or RQFII quota, of Chinese asset managers to buy the Class A funds, the people said. Angel Yeung, a Hong Kong-based spokeswoman for UBS, declined to comment.

The Shanghai Composite Index has lost almost one-third of its value since a June 12 peak, reversing a spectacular run driven in part by buying from highly leveraged individual investors. Authorities have cut interest rates, relaxed margin-lending rules and pledged liquidity support to the market as they fight to contain the $3.5 trillion rout.

The volatility has created a good entry point for the notes UBS is marketing, the people familiar with the matter said, asking not to be identified because the details are private.

UBS is targeting ultra high-net-worth individuals at first and limiting sales to $100 million to $150 million, the people said. The offering is expected to close July 10.

The notes are being sold in Hong Kong and Singapore and interest has come mainly from Chinese and Taiwanese offshore investors, they said. The product is currently only being sold in Asia due to regulatory constraints in Europe and U.S., the people said.

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