Barclays' annual reset notes tied to Russell 2000 seen as too long in rising rates environment

By Emma Trincal

New York, Dec. 19 - Barclays Bank plc's annual reset coupon buffered notes due Dec. 31, 2019 linked to the Russell 2000 index give investors a downside buffer and a guaranteed coupon that varies based on the underlying index. But advisers said that the six-year tenor presents too much interest rate risk in today's market as rates are expected to rise.

Interest is payable annually and will equal the maximum digital percentage if the index's return for that year is positive or zero. Otherwise, the coupon will equal the minimum digital percentage. The index's return will be measured from its level a year earlier, according to a 424B2 filing with the Securities and Exchange Commission.

The maximum digital percentage is expected to be 6% to 7%. The minimum digital percentage is expected to be 2.1% to 2.25%. Both will be set at pricing.

The payout at maturity will be par unless the final index level is less than 80% of the initial index level, in which case investors will lose 1% for every 1% that the index declines beyond 20%.

2% to 7%

The notes give investors income and have a relatively low downside risk, said Steve Doucette, financial adviser at Proctor Financial. But he questioned the timing and objected to the duration of the investment.

"The best you can get is between 2% and 7% a year. The buffer gives you 20% downside protection against the losses, and if it's not enough, the accumulated coupons may offset all or some of it," he said.

"The chances of losses are pretty slim. It's a six year, and in a normal market cycle, we should have gone down and would probably be back up by then.

"If somebody is comfortable getting 7% a year, with in theory 80% of their principal at risk, then they may look at it. I'm not a big fan of annuities, but if you are, this is an annuity substitute in a low rate environment.

"When you have a rising rates environment, however, it's not such a great idea."

Doucette, who wants to be able to sell a structured note prior to maturity on the secondary market, said that the combination of a long maturity and an equity index may create pricing issues.

"From my perspective, the duration is too long, especially for something tied to the Russell, which is going to make the pricing very volatile. If you need to get out in the interim, it's going to be a volatile ride for the pricing of this asset," he said.

No participation

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he also does not like the long duration, especially for a payout capped at the coupon level with no upside participation.

"The longer term is a concern for me. I do like Barclays as an issuer, and you do have to look at that when you go long term. But I'm not too thrilled about the terms. If you get 2% a year, it's barely more than what the index pays in dividends," he said.

The Russell 2000 has a 1.5% dividend yield.

"In this market environment, I probably wouldn't want to lock in a six-year note with interest rates potentially going up," he said.

"If I'm using the Russell 2000 as an underlier, I would prefer using it as my appreciation instrument. This note delivers income, not any participation in the index. I would prefer the upside."

Even for income-seeking investors, Medeiros said that the Russell 2000 is probably not the best benchmark to use as an underlying.

"If I was looking for yield, I would much rather look at notes tied to higher-yielding indexes," he said.

"I would search for a product that provides consistent and more predictable dividends, probably through the use of a total return index so that I get exposure not just to the price but to the dividend return as well.

"I wouldn't want to be stuck in a long-term instrument with interest rates on the way up."

Timing

A buysider who used to buy a lot of structured notes but has reduced his activity in this sector agreed that the timing of the product, just after the Federal Reserve took the first step to taper its bond-buying program, may not be best.

"My one problem with it is that just like now is not a good time to get locked in in long-term fixed income, it's not a good time to get locked in in long-term structured products," this buysider said.

"Funding levels have been so bad we've sort of stepped out of structured products a little bit and tried to replicate the payouts with options.

"I would probably replace this by covered calls on the Russell. I could earn a little bit of income with the premium."

Barclays is the agent.

The notes will price Dec. 27 and settle Dec. 31.

The Cusip number is 06741T2P1.

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