Timing makes the difference between two Barclays deals on an international basket

By Emma Trincal

New York, Oct. 16 – Two note offerings on a basket of international equity indexes offered enough similarities to be worth a comparative analysis although they fundamentally address different needs for different types of investors, sources said. What really distinguishes the two investments is time.

Two leveraged notes

Barclays Bank plc will price two different issues of leveraged notes tied an unequally weighted basket of non-U.S. equity indexes.

The basket is the same (components and weightings) on both deals, according to two separate 424B2 filings with the Securities and Exchange Commission.

It consists of the Euro Stoxx 50 index with a 40% weight, the Nikkei 225 index with a 20% weight, the FTSE 100 index with a 20% weight, the S&P/ASX 200 index with a 7.5% weight, the Swiss Market index with a 7.5% weight and the Hang Seng index with a 5% weight.

The first offering – Barclays Bank plc’s 0% capped gears due Dec. 31, 2018 – pays at maturity par of $10 plus triple any basket gain up to a maximum return of 16.25% to 18.25%.

Investors will be exposed to any losses.

The second deal – Barclays’ 0% trigger gears – is a longer-dated note (it matures on Oct. 31, 2022) with slightly less upside leverage with a 2.35 to 2.45 times leverage factor. On the other hand, it brings to investors the advantages of a contingent protection on the downside (80% barrier) as well as uncapped returns on the upside.

“Both deals bring something different to the table,” said Michael Kalscheur, financial adviser at Castle Wealth Advisors.

Popular basket

The common basket used in the two notes was attractive, he said.

The basket is not new. Just this year, the basket has been employed in eight different offerings totaling $166 million, according to data compiled by Prospect News.

This underlying, which sometimes comes with different weightings and slight changes in one or two minor components, has been said to serve as a proxy for the MSCI EAFE index, the benchmark for the equity performance of developed markets at the exclusion of the U.S. and Canada.

“It’s a nice way to get international exposure. I haven’t seen it before but it’s a well-diversified basket, not something they’re throwing against the wall to see if it sticks.

“And it’s a basket, not a worst of. We like that.”

Equity bet

But Kalscheur pointed to the important differences between the two deals.

“The first is almost an equity play. While the cap is high, in fact it’s pretty high... you’re still going to be capped out easily with three times up. It’s for somebody who believes that the market will be below average expectations.”

Indeed it would only take an annual growth of 4.65% of the basket to enable investors to hit the 16.25% hypothetical cap, which represents a 13.80% annualized compounded return, he noted.

This view would make sense for any “somewhat bullish” investor who believes the market had a “nice run” and is now likely to “revert to the mean,” he said.

But Kalscheur’s main objection to the structure based on his own investment style was the lack of downside protection.

“We do use structured notes in the first place as a way to get market exposure while taking some risk off the table,” he said.

“This for us is very similar to replicating the indexes. It’s close to a pure equity play. If I was looking for a short-term equity investment, I would consider it to stack up against a long-only position.

“But this is not what we do as a firm. We’re more inclined to look for long-term growth, and we need the protection on the downside.”

Kalscheur looked at the cost, saying that the 2% underwriting discount over the 14-month period, disclosed in the prospectus, “was relatively high but they’re giving you enough leverage.”

“I would say it’s not a bad offering for somebody looking to get a pretty high return over a short period of time. You can outperform in a flattish market.”

Long-term, good terms

But Kalscheur said that he preferred by far the second deal, the five-year note, as it offers unlimited upside and contingent protection.

Extending the duration was the main concession investors had to make in order to get those benefits. For Kalscheur, long tenors are not a concession.

“We like to be invested long term. This is also what we do as a firm. As you go longer, by default, you’re going to get much better terms,” he said.

Another “concession” was to accept the slightly lower leverage multiple down to the 2.35 to 2.45 range from 3.

This seemed like an easy price to pay too, he said.

“You don’t have 300% but anything over 200% is very significant. In fact I consider 150% to be very good,” he added.

Finally the unlimited return was even more compelling.

“No cap. That’s fantastic! We almost always do no-cap,” he said.

This is one of the reasons Kalscheur prefers to go long term.

With a hypothetical example of 10% return in the basket based on 2.35 time leverage, he could double his clients’ investments over five years, he said.

“You can have potentially explosive returns over this period of time.”

While his firm is conservative in nature (notes with full downside risk exposure are rarely under consideration) Kalscheur said he is selective with caps.

“We really want the upside potential. If you’re going to buy equities that’s what you want.”

Back testing

Finally Kalscheur said he liked the barrier but would have to be able to assess his risk running some back testing, which is less easy to do with a basket of six indexes than it is with the S&P 500 index or the Euro Stoxx 50.

“The big question here is: what is your probability to see a 20% drop for any five-year rolling period in the last two or three decades? I’d have to research that,” he said.

Such analysis is especially important with a barrier, he noted.

“This is a barrier, not a buffer. An equity investor would get the equivalent of a buffer with the dividends. But not with this,” he said.

Dividend payments by definition are part of the features investors in structured notes need to forgo in order to get some of the terms they seek, which are not available to equity investors, he added.

“It’s the usual tradeoff,” he said.

The weighted average dividend yield of the basket was in the neighborhood of 2.55%, he said.

“You’re giving up some decent income over the period. Instead of having a 12.80% buffer, you have a 20% barrier,” he said.

“The good thing is that it’s a pretty decent size barrier. If I have an X% chance to breach and X is 5% for instance, then it’s probably worth taking the risk of having a barrier.”

In conclusion, Kalscheur said he was “impressed by this deal” adding that the 3.5% fee over five years was “very competitive.”

“It’s a compelling product,” he said.

“I would have to be crunching the numbers for the downside. But it’s worth crunching.

“We’re going to take a look at it.”

Goldman’s red flag

A market participant agreed that time was the main distinguishing factor between the two products.

“You have a 14-month on the one hand and a five-year on the other hand. It really depends on your point of view and how long you would want to be locked in,” he said.

Even if the issuer provides a “decent price” to buy back a note, “it’s hard to get out of a note,” he added.

“Time is the tradeoff.

The first note consisted in a “super- short view,” which made it more attractive for investors who need liquidity.

“But if it was me, personally I would look for the long-term. First you’re not losing much in leverage. And you have the upside, which makes it really worth it.”

His main motivation however was risk aversion. There are reasons to be concerned about the market over the short-term, he said, citing a Goldman Sachs’ research paper published last month. Named "Bear Necessities: Should we worry now?", the piece authored by Peter Oppenheimer, Goldman’s chief global equity strategist, predicted an 88% probability that the S&P 500 index will hit bear market territory within two years based on the firm’s GS Bear Market Indicator model.

He said he tended to agree with this view.

“Looking long-term is probably better. I do believe that now is probably the worst time to get into the market without protection,” he said.

Barclays and UBS Financial Services Inc. are the agents for both offerings.

Both deals will price Oct. 27.

The Cusip number for the 14-month note is 06746M479.

The five-year Cusip is 06746M446.

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