Barclays’ $118.18 million leveraged notes tied to S&P 500 top last week, show bulls want more

By Emma Trincal

New York, July 16 – Barclays Bank plc’s $118.18 million issue of 0% Accelerated Return Notes due Aug. 28, 2015 linked to the S&P 500 index was the largest offering last week, signaling that demand for return enhancement remains strong as market valuations keep on rising, sources said.

If the index return is positive, the payout at maturity will be par plus 300% of the index return, subject to a maximum return of 10%. Investors will be fully exposed to losses if the index declines, according to a 424B2 filing with the Securities and Exchange Commission.

The final index level will be the average of the index’s closing levels on the five trading days ending Aug. 25, 2015.

BofA Merrill Lynch was the agent.

Low expectations

“Everyone is trying to reach for returns,” said Jack Ablin, chief investment officer of BMO Private Bank.

“For one, it was obviously a popular deal. People must have a certain view for it. Beauty is in the eye of the beholder.”

The “view” is moderately bullish, according to the prospectus, which explains that investors are willing to cap their returns given their modest expectations for the market. A willingness to give up dividends and to risk a loss of principal is the required trade-off in order to get three times the upside return, according to the prospectus.

Complacency

While short-term leveraged notes typically don’t offer downside protection, as it is the case with this product, some sources said the timing of this and its size reflect complacency on the part of investors.

“With markets at [an] all-time high, people are going to tie [up] their money for one year with no downside protection at all, and they don’t really have much choice. Volatility is so low. They can now price three times leverage instead of two, but you’re not going to get the 10% or 15% buffers you used to have. Those are gone. They just can’t price the downside protection anymore,” an industry source said.

“Whether they realize it or not, retail investors are taking on some significant risk with these notes. It’s definitely a sign of complacency. We keep on reaching new market highs. At some point, we’re going to have a pullback.”

The S&P 500 is up 7.25% this year to date. The index has gained 21.75% from its 52-week low in August 2013 and is up nearly 14% from its low for the year in early February.

On Wednesday, another U.S. equity benchmark, the Dow Jones industrial average, closed at a record high level for the 15th time this year.

“People have forgotten about the financial crisis. They think the market can go up forever,” the industry source said.

“When you look back earlier this year, the overall sentiment was much more skittish. But the market has rallied since then, and everyone is coming up with new, upbeat forecasts.”

Narrow window

A market participant also criticized the structure but mostly from the upside standpoint, saying that the return potential is limited.

“The only concern obviously is that you’re giving up the dividends on the S&P. The window of superior performance over the S&P outright is so narrow, I wonder if it makes sense,” this market participant said.

“With a 2% dividend yield, you’re really outperforming the index if the S&P is up between 3% and 6%. It’s a small narrow window of possible outperformance. The customer is gambling on a very small potential pickup. You’re not picking up that much gain, and your downside is just about the same if not slightly worse. I don’t see any value.”

This market participant said his main “concern” with the structure is not so much on the downside.

“It’s roughly the same risk as owning the index. You’re always going to underperform but by only 2%, so it’s not as if you were picking up a whole lot of extra risk compared to the direct investment in the SPDR.”

The SPDR S&P 500 ETF Trust is the exchange-traded fund that tracks the performance of the S&P 500 index.

“The risk here is that you limit your chances of beating the index. If you’re bullish on the market, why not just buying the ETF itself?”

Mom and pop

This market participant compared the deal to a similar offering seen last week, Barclays’ $51.51 million of 0% Accelerated Return Notes due July 22, 2015 linked to the share price of Facebook Inc. The main difference is the underlying. The Facebook notes offer no downside protection. The upside is leveraged at a factor of three and capped at 31.2%.

“Both have the same downside risk as the underlying, but I don’t mind that much the Facebook deal because the person you discuss the deal with is probably interested in Facebook in the first place and familiar with the volatility associated with it,” he said.

Even though this market participant does not consider the downside risk exposure to be the main problem with the $118 million deal, he noted that advisers have to be extra cautious when showing index-linked notes.

“I’d be more concerned with the S&P deal. Mom and Pas buy a lot of S&P. It’s not that brokers would be malicious in their explanations, but I think there’s more potential for misunderstanding and disappointment when you’re talking about those types of leveraged notes on a well-known benchmark.”

The S&P 500 notes (Cusip: 06742W109) priced on July 8.

The fee was 2%.

© 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.