Barclays’ Accelerated Return Notes tied to stock basket show high cap, bullish play

By Emma Trincal

New York, Jan. 12 – Barclays Bank plc’s 0% Accelerated Return Notes due March 2018 linked to a basket of three equally weighted financial sector stocks offer a high cap on a short maturity, all factors that may appeal to bullish investors, sources said. But the tradeoff is a full exposure to the downside market risk, according to an FWP filing with the Securities and Exchange Commission.

The underlying stocks are Citigroup Inc., JPMorgan Chase & Co. and Morgan Stanley & Co. LLC.

The payout at maturity will be par plus triple any basket gain, up to a maximum return of 20% to 25%. The exact cap will be set at pricing.

Cap

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said that the cap level was sufficiently high to satisfy a bullish appetite.

He noted that all three stocks have soared since the Presidential elections.

Morgan Stanley has jumped 33% while JPMorgan rose by 28% and Citigroup by 23%. For the basket, this represents in only two months an average return of 28%.

“I’m bullish on the sector but given the recent bull run, I don’t think these huge returns are sustainable even short term,” he said.

The cap however was high enough to satisfy a rather bullish bet, he said.

The maximum cap range of 20% to 25% over the 14-month tenor represents a return of 17% to 21% a year on a compounded basis.

“I may be bullish, I am not too worried about being capped out on this one,” he said.

“The leverage is pretty substantial. It’s also one side only, which is great,” he said.

Replicating the leverage with a direct investment in the basket would be costly and complex.

“You would have three times up and three times down unless you buy some puts. Clearly the note with the asymetrical leverage is more efficient.”

Downside

Medeiros said he is bullish on financial stocks because the interest rate environment is rapidly changing.

“These three stocks have done quite well in a challenging period of time with low interest rates.

“Now that rates are rising the fundamentals for those stocks has improved.”

In general, Medeiros buys structured notes with a buffer or barrier. But this particular product could justify an exception.

“It’s always better to have a buffer but my return expectations are positive. Also it’s a 14- month. It’s unrealistic to ask for a buffer on a 14-month. But I’m not too concerned with the downside. I think in the short term, the financial sector should appreciate quite nicely,” he said.

Limited upside risk

Typically, Medeiros said, he also chooses to “stay away” from caps.

“But this one is really good. Who wouldn’t want a 20% return?

“Compared to a non-leveraged investment I’m still ahead of the game up to a 20% return,” he said.

The payout was consistent with Medeiros’ return expectations, especially just after a strong rally.

“It has a very attractive upside. I do like the notes. It gives you the opportunity to capture a strong bullish return in a very short period of time,” he said.

Alpha

Steve Doucette, financial adviser at Proctor Financial, had a different view. For him, the notes were not a good fit because he strives to use structured notes to generate alpha.

“It gives you only a pretty narrow range to outperform,” he said.

“When I buy a note, I want to beat the market on both sides.”

Without any barrier or buffer, Doucette said he has no chance to outperform the basket’s performance if the stocks move to the downside.

“I tend to be bullish. But you can always be wrong. This one doesn’t allow you to be wrong,” he said.

His greater objection however was the cap.

“Again I need to outperform the stocks. There is a lot of leverage so the minimum to hit the cap isn’t that high. All it takes is more than 6% or 7% a year to be capped out. After that you’re not outperforming the underlying.”

Risk-adjusted return

Doucette said it is possible to see bank stocks rallying further.

“A rising interest rates environment has often been good for banks because it improves their margins. If Dodd Frank goes away, it frees out some of their activities, it can open up the doors for some of these folks.”

The absence of any downside protection and the existence of a cap made for a structure that did not offer a solid risk-adjusted return even though the cap was fairly priced.

“Obviously, you’re bullish on the banking sector otherwise you would get some protection. But you’re not that bullish. To maximize the gain all you need is 6%,” he said.

“If the stocks go up by more than 20% you’re underperforming. If they go down you’re not doing better.

“I’d rather have a little bit of protection and a little bit of leverage.

“Most people expect rates to go up and bank stocks to rally. But you could be wrong.”

The downside protection was really the missing piece, he concluded.

BofA Merrill Lynch is the agent.

The notes will price in January and settle in February.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.