Barclays’ SuperTrack notes tied to Russell, the Dow offer high leverage through worst-of

By Emma Trincal

New York, Nov. 10 – Barclays Bank plc’s 0% SuperTrack notes due Nov. 30, 2022 linked to the lesser performing of the Russell 2000 index and the Dow Jones industrial average show how worst-of structures can be used out of the sphere of income products in order to improve the risk-adjusted return of a note, said Suzi Hampson, structured products analyst at Future Value Consultants.

The notes will pay at maturity par plus 2.5 times the gain of the worse performing index up to a maximum return of 57% to 60%, according to a 424B2 filing with the Securities and Exchange Commission.

If either index falls by up to its 60% barrier level, the payout will be par.

Otherwise, investors will lose 1% for each 1% decline of the worse performing index.

Worst of, leverage

“We rarely see worst-of with leverage, so that’s interesting,” said Hampson.

“Worst-of are usually seen with yield products, mostly autocalls rather than growth products. But using multiple assets in a leveraged structure can improve the economics of a deal.”

The 60% barrier reflected the relatively longer maturity, she said.

“You’ve got 2.5 times up to the cap. That’s significant. Because you have the worst-of, you can get higher gearing than if you only had one underlying.”

But the issuer picked “two big U.S. equity indices” for the worst-of, which lessened the risk as those are less volatile than single-stocks or even some less broadly diversified exchange-traded funds, she added.

In addition, the risk was also mitigated by the high correlation between the two indexes.

“If those two move together – and they do to a certain extent ...they have a correlation of 0.86 – your risk to see one going up while the other goes down is lower. That’s what you want,” she said.

Finally the cap – which Hampson set at 58.5% in order to produce her stress test report – was “quite attractive,” she said.

“By using a longer than usual tenor plus a worst-of, this issuer was able to provide a pretty good return with some decent protection. There is additional risk with two underlying, but those are broad indices and they’re highly correlated.”

Stress tests

Future Value Consultants provides stress test reports for structured products. Each report shows 29 different “tables” or tests, which include Monte Carlo simulations and back testing analysis.

For its base-case scenario, the firm uses a “neutral” assumption, which is “risk neutral” and based on standard pricing off the risk-free rate.

The model also offers four different market assumptions to provide more realistic outlooks. Those are: bullish, bearish, less volatile and more volatile. Each scenario lies on a hypothetical growth, which is designed to be conservative. For instance the annual rate of return for the bull scenario in this report is 4.9% for the Dow Jones industrial average and 6.8% for the Russell 2000.

Easy cap

One of the tables in the report, the product specific test, offers probabilities for two important outcomes, which are barrier breach and maximum return, in other words, losses or cap.

In the bull scenario, the probability of losing money is only 4.24% while hitting the cap happens 50.71% of the time, this table showed.

“The bull scenario is the best even if our growth assumptions are very moderate,” she said.

“You want to use this bullish assumption because as an investor this is going to be your expectation.

“If you’re bullish and happy with the double-digit maximum return, this product is expected to cap you more than half of the time, which is good.”

Part of this positive result is due to the high leverage factor. A 58.5% cap over five years represents a 9.65% annual compounded return, which can be obtained very easily, she explained.

It would take only a 4.3% annual growth for the worst performing index to allow investors to achieve the best possible return.

“That’s not asking too much,” she said.

“The high gearing is what increases the odds of getting there.”

On the downside the 4% probability for one of the two indexes to fall below the 60% barrier threshold is “very low,” she said.

“If you compare this probability with other products we’ve recently reviewed, the chances of losing money are very small and that’s due to the low barrier,” she said.

“The worst-of may add some risk premium. But because the issuer picked two indices that have a low volatility and a high correlation, the structure achieves a pretty decent balance between risk and return.

Getting nothing

The analysis would not be complete without a look at a few other outcomes, which is the focus of another table called capital performance tests.

This table adds more detailed information, describing a “return exactly capital” outcome, the situation in which the index finishes negative but above the barrier allowing investors to get their principal back with no losses but no gain. There is a 21.68% probability for this outcome in a bull market, according to this table.

On the positive side, all positive outcomes add up to a 74% probability. This includes the 51% probability to hit the cap, leaving investors with a 23% chance of getting a positive return anywhere between par and the cap.

“This note will make money three-quarter of the time, and half of the time it will be the cap,” she said.

“Losses occur only 4% of the time.

“Anything in between is an opportunity cost,” she said referring to the 22% chance of getting only one’s principal back.

“You have invested money for five years with no profit. But high returns don’t come free, and that’s one of the risks you’re taking. In terms of probabilities, this is your most likely but not your worst case scenario among the bad outcomes.”

Average payoff

The capital performance tests also reveal the average payoff for each outcome.

“While unlikely, the loss scenario is going to hurt a lot, but that’s true anytime you have a low barrier,” she said.

When investors lose some principal in less than 5% of the time, they will incur a substantial loss of 54.6% in average in the bullish scenario. The average loss would rise to 61.9% in the bearish case.

“If you lose, which is unlikely, you are going to lose big,” she said.

The same capital performance test can be seen under a back testing analysis.

When it comes to the positive outcomes, the simulation and the back testing have comparable probabilities.

For instance getting a positive return (at or below cap) happened 71.38% of the time over the past 10 years, which is close to the 74% projection.

“It’s on the risk and loss side of the equation that we see a greater divergence between the simulation and the back testing,” she said.

The barrier breach outcome represents a 4.24% probability in the simulation but has happened less than 0.1% in the last 10 years.

“We know we had a very strong bull market. So it’s very small. Plus your losses are lower if it happens,” she said commenting on an average loss of 40.40% in the back testing versus nearly 55% with the simulation.

“Compared to an ETF, your return is capped. But you have the protection. This is an interesting use of a worst-of that gives you a high gearing. For investors who want U.S. equity exposure, it’s a reasonable alternative to an ETF.”

Barclays is the agent.

The notes will price on Nov. 27.

The Cusip number is 06744CKC4.

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