Barclays’ Super Track notes tied to Russell 2000, S&P 500 combine worst-of with participation

By Emma Trincal

New York, Jan. 28 – Barclays Bank plc’s 0% Super Track notes due Jan. 29, 2021 linked to the lesser performing of the Russell 2000 index and the S&P 500 index give investors leveraged and uncapped upside participation through a worst-of payout structure more usually employed with income products.

If the final level of the lesser-performing index is greater than its initial level, the payout at maturity will be par plus 205% of the return of the lesser-performing index, according to a 424B2 filing with the Securities and Exchange Commission.

If the lesser-performing index remains flat or declines by up to 35%, the payout will be par.

If the lesser-performing index declines by more than 35%, investors will be fully exposed to its decline.

Not income

The structure is somewhat unusual as worst-of products tend to deliver a coupon instead of participation in a reference asset, according to data compiled by Prospect News.

Steve Doucette, financial adviser at Proctor Financial, saw opportunities with this product. He has invested in worst-of products in the past, but those were contingent autocallable notes, which he said he used as “potential” fixed-income substitutes.

Peace of mind

With this note, investors benefit from a deeper barrier, probably as a result of the deferred payout, he said.

Doucette said the downside protection featured in the notes would appeal to many investors concerned about the U.S. equity market, which has been in negative territory since the beginning of the year.

“A 35% barrier five years out ... I don’t know if the protection component will ever play out, but it provides the peace of mind necessary to navigate this environment,” he said.

Another “peace of mind component” was the pricing itself.

“The market has already dropped 10%. Even if we go through a bear market – and historically it will happen within the next five years – you get levered out from this lower entry point and your protection will price at a lower level. The current sell-off allows you to reset the protection at an even lower strike.”

Correlation

When stock prices trend up, the Russell 2000, which tracks U.S. small-cap stocks, tends to outperform the large-cap universe represented by the S&P 500 index, he noted. When the market declines, however, the Russell 2000 is more vulnerable to losses.

“You have exposure to the worst performer between the S&P 500 index and the Russell 2000,” he said.

“In a down market, small caps are more volatile. If you burst the barrier, that’s where it will happen.

“But if you’re up, chances are the Russell will outperform. At least it has been the case historically.”

According to that scenario, investors would get exposed to the Russell 2000 index on the downside and to the S&P 500 index on the upside.

“It’s not an absolute certainty. We’ve seen the S&P outperforming the Russell during uptrends like the dot.com bull market of the late 1990s,” he said.

“Some people would make the opposite assumption. So whether the S&P or the Russell outperforms in a bull market, what I want to avoid is getting the lower return for the index that underperforms the other.”

More gains

Doucette reasoned that the downside was not his main consideration. The barrier size and the low entry point contributed to lessen the risk. Even the five-year maturity was a positive factor because the longer tenor may give a bear market enough time to run its course.

“I would want to capture more of the upside,” he said.

“Being subject to the worst index on the downside is fine. You get paid for that. That’s how you get the leverage and that type of protection. I can live with that.”

Doucette said he might want to reconstruct the deal.

Best of, worst of

The financial adviser has an ongoing dialogue with sellsiders and renegotiates terms of products he wants to make more suitable to his clients. In this case, he would leave the downside exposure unchanged but would substitute on the upside a “best-of” option for the “worst-of.”

A best-of works in a similar way as a worst-of except that investors participate in the return of the best-performing index instead of the worst.

“I would be willing to reduce the leverage. I haven’t priced it, and it may not work, but I’m honestly thinking you might be able to do that at 1.75 times.”

He explained why the worst-of would have to be maintained on the downside.

“Using the worst-of option gives you more premium. That’s how they can get that leverage. I would be willing to get less leverage for the benefit of using a best-of option on the upside,” he said.

“I know it can be done. We have looked at these types of options before.”

Challenging

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said the worst-of feature was particularly challenging from an asset allocation standpoint. He would not consider the product for his clients.

“I’m not a big fan of the worst-of scenarios, especially over a long period of time like five years,” he said.

The challenge of monitoring the notes is to create some predictable outcome for the position.

“Tracking the two indices over a five-year period generally speaking is not that challenging.

“But calculating the leverage on the upside, monitoring the position based on the protection, that certainly takes time.”

Asset allocation, risk

Medeiros explained that managing risk is an ongoing process even when investors do not receive any payment prior to maturity.

“You always have to gauge the risk of the strategy. I look at it from a risk budgeting perspective. ... Where are my opportunities, and where would I spend my risk?” he said.

Correlation between the two indexes is part of the risk assessment, adding more complexity to the process.

“I’m not sure where my return would come from. I could benefit from the upside but also get hurt on the downside.”

He explained why the complexity of this form of risk control may interfere with the way he manages his portfolio.

“The idea that I have more risk with the Russell than I do with the S&P has an impact on my asset allocation. It is an asset allocation decision that you have to make,” he said.

Research over a series of five-year periods would likely reveal that the odds of breaching the barrier for either one of the indexes are small if not null, he said.

In addition, the 35% barrier, which he said “is not bad,” and the current “double-digit pullback” provided additional safety.

“My concern is not the protection. My concern is that I still have to manage the risk, and I don’t know if I’m budgeting for small-cap risk or for large-cap risk.”

Barclays is the agent.

The notes were scheduled to price Jan. 27.

The Cusip number is 06741U4H4.

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