Barclays' digital notes linked to Russell 2000 offer defensive play, but return disappoints

By Emma Trincal

New York, Sept. 27 - Barclays Bank plc's 0% digital notes linked to the Russell 2000 index may give investors a better chance to receive the digital payout due to a lower threshold, but the return remains below average compared to similar products, said Suzi Hampson, structured products analyst at Future Value Consultants.

Some of the terms of the notes are not fixed yet and will be set at pricing, a factor of uncertainty that may have an impact on the final score of the notes, she said.

The duration is expected to be 21 to 24 months, and the digital payout, or cap return, will be between 8% and 9.5%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index return is greater than or equal to negative 15%, the payout at maturity will be par plus the cap return. If the return is less than negative 15%, investors will lose 1.1765% for every 1% that the index declines beyond 15%.

Lower threshold

This digital product differs from many others in that the threshold level, which triggers the digital payment, is set at a lower level than the usual initial index level, Hampson said.

Another difference, she added, is that the threshold for the payout and the threshold for the protection are the same, while they are at different levels in most products of the same type.

"There is only one level to get paid the digital and get protection in this product, which is the 85% threshold. In other digital structures, you get the digital payout when the underlying is above 100 and you have a protection at a lower level. Here you can get the return even if the index is negative. You're either above 85%, in which case you get your payout, or you're below and you lose some principal," she said.

"The protection offered is very good. It's a 15% buffer. It's more protective than an 85% barrier and obviously completely different from having no downside protection at all."

Buffer

"We've got this downside gearing of 1.1765%," she said. "Even though it's a buffer, the acceleration on the downside can make you lose your entire investment, which is what this leverage factor does: It just brings you down to zero. For each 1% of decline in the Russell, you lose a little bit more than 1%. But even still, your protection remains better than what you would get from an equivalent barrier."

She gave an example: If the index finished down 20%, investors would lose about 5.9%.

"For a 20% decline, you would have just lost under 6% of your investment. It's not a big loss for such a large market drop. It's certainly less than what you would lose if you were invested in the fund or in some sort of tracker note," she said.

Investors in the notes choose a possibly lower return for the benefit of this extra protection, she explained.

"It's a reduced risk kind of play," she said.

"A very bullish investor with a high risk tolerance would not be interested in this. It's what you may call a defensive product.

"Some notes pay you when you're above 100. This one, when you're above 85. It's better. In exchange, you're not going to get that much return. That's the sacrifice you make for increasing the likelihood of getting that return.

"It's for a more conservative investor. However, investors need to remember that they can lose their entire investment. It's still a capital-at-risk product. There is some level of market risk and credit risk to take into account."

Riskmap

Future Value Consultants in its research assess risk, return and price using a variety of proprietary scores in order to compare a product with others.

The riskmap is Future Value Consultants' measure on a scale of zero to 10 of the risk associated with a product with 10 as the highest level of risk possible.

The product has a 3.08 riskmap. The average riskmap for products of the same type is 3.62.

The riskmap consists of two equal components: market risk and credit risk.

While the credit riskmap of the notes is only "slightly" higher than average, its market riskmap is well below the average, she said.

The market riskmap is 2.22 versus an average of 2.91 for the same product type. The credit riskmap is 0.86, and the average, 0.71.

"The 15% buffer is the main factor here and is quite attractive when you compare it to other products that have no downside protection or that are tied to more volatile assets," she said.

"You get a market risk that's a lot lower, which is not surprising. It's the buffer effect.

"The credit risk is not that much higher. It's still pretty average."

Barclays' five-year credit-default swaps spread is 126 basis points versus 134 bps for Morgan Stanley, 104 bps for Bank of America and 89 bps for JPMorgan, she noted.

Return score

Future Value Consultants uses its return score to evaluate the risk-adjusted return of a product. The score is calculated using five key market assumptions: neutral assumption, bull and bear markets and high- and low-volatility environments.

The notes have a return score of 6.09, compared with the average score for digital products of 7.47.

"You'd expect to get a lower return because you have a lower risk profile than many other products. The trigger for the digital is lower, so your chances of getting paid are higher," she said.

"However, the amount of return still needs to be in line with what's available, and it looks like you're not getting paid enough compared to the average.

"You may get this lower threshold for the return, but in this case, your return is not very competitive. You still have to compete with other products."

Price, overall scores

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The notes have a 4.96 price score. In comparison, the average price score for digital products is 7.32.

"We're not looking at a very good score here," she said.

"It's not performing very well compared to the market. The low price score suggests not enough was spent on the assets. The issuer perhaps should have offered a higher digital return."

The price score, however, is subject to adjustments and will improve if some of the variables change in a more favorable direction, she explained.

For instance, the research firm picked for its scores a 24-month duration, which is the higher end of the range, based on its methodology.

"Should the issuer decide to make it a 21-month product, the price score would improve substantially," she said.

For the hypothetical return used in the report, Future Value Consultants assumed a cap return of 9.125%, which is 25% below the upper end of the 8%-to-9.5% range, also in accordance with its methodology.

"Obviously, the score would improve a lot if they were to pick a 9.5% return," she said.

"For now, however, the price score is really below average.

"If both variables were to change for the best - if they did 21-month with 9.5% cap - it would make a big difference in the score. So we have to [wait and] see until they price it.

"The maturity would have an even bigger effect on the return score.

"Sometimes with growth products you get a better return score with longer terms. But when you're capped out, it's the opposite. Your score improves when the maturity is shorter."

Future Value Consultants offers its opinion on the quality of a deal with its overall score. The score is simply the average of the price score and the return score.

The notes have a 5.53 overall score. By contrast, the average overall score for the product type is 7.40.

"The overall score is extremely disappointing. It's way below par," she said.

"The price score is the worst of the two. But not having a good return score certainly doesn't help.

"It looks appealing to have an 85% threshold to get your cap. But that's not enough. From the score standpoint, the return should be higher or the maturity should be less.

"We just have to see how the product settles."

Barclays is the agent.

The Cusip number is 06741TN78.

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