Barclays’ five-year step-up autocallables linked to Russell seen as short, mildly bullish play

By Emma Trincal

New York, Oct. 30 – Barclays Bank plc plans to price 0% market-linked step-up notes due November 2022 linked to the Russell 2000 index, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par of $10 plus an annual call premium of 5.5% to 6.5% if the index closes at or above the initial level on any of four annual observation dates. The exact call premium will be set at pricing.

Advisers interviewed for this article assumed a hypothetical call premium of 6%, the mid-point of the range.

If the notes are not called and the index finishes above its step-up level, 135% of the initial level, the payout at maturity will be par plus the gain.

If the index gains by up to the step-up level, the payout will be par plus the step-up return of 35%.

Investors will receive par if the index falls by up to 15% and will be exposed to any losses beyond 15%.

Loving it

Carl Kunhardt, wealth adviser at Quest Capital Management, was very upbeat about the product.

“I love it,” he said.

“You’re taking small cap, an asset class that you always have to be exposed to anyway.

“It’s an asset class that doesn’t tend to pay a lot of dividends, so the fact that you’re giving up dividends is irrelevant.

“And if you get to the fifth year, which is unlikely, all the index has to do is be flat and you get a guaranteed return.

“You get a buffer. I love buffers.

“What’s not to like?”

In line with outlook

Kunhardt said the 6% call premium meets his mildly bullish expectations for future equity returns.

“We’re no longer in the 1990s when 20% a year was normal. In the upcoming years, 6% a year is going to be the new normal,” he said.

“This deal gives you 6% without taking a whole lot of risk. I’m totally OK with it.”

Too short

Only the early redemption is a possible drawback.

“You’re very likely to be called after one year. It’s such a great note. You’re not going to get past the first year, and if you are, you’re not going to see the end of the second year.

“You’ve got the reinvestment risk then because you’ve got to do something with the money.

“That’s the only downside.”

One year

Michael Kalscheur, financial adviser at Castle Wealth Advisors, was also convinced that the notes will be called early on.

“I like the issuer. No problem with that. The index is good. The step up at the end with the buffer is good too. But I don’t think you’ll get to benefit from it anyway. The chances of making it to maturity have to be small,” he said.

Since the probabilities of being called are high, he said, the upside will most likely be limited to the call premium.

When reviewing a note, this adviser uses back testing to assess probabilities of return outcomes based on the performance of the underlying index. For this product, Kalscheur used Russell 2000 performance tables since 1987.

He found that for any one-year rolling period, the chances for the Russell to be positive were 70%.

Based on that, he projected roughly a 70% chance for the notes to be called at the end of the first year, giving investors a 6% return.

Too low

He then estimated how likely investors are to beat the market under this scenario.

Investors only outperform with the notes if the Russell 2000 is lower than 6% a year because that’s when they benefit from the digital return, or “step.” The Russell 2000 has shown a one-year return comprised between zero and 6% over the past 30 years only 11% of the time, he said. As a result, Kalscheur concluded that the note would underperform the index 59% of the time if called on the first call date, after one year.

“The chances of being taken out are high ... about 70% of the time. And when I’m called, the chances of underperforming the equity are 60%, which is also high,” he said.

The 15% buffer on the other hand is unlikely to be put to use. That’s because not being called four years in a row is an extremely unlikely scenario in his view.

High expectations

“What you’re really getting is 6% a year. It’s nice, but why do it through an equity structured note?” he said.

“If I base my return off an equity index, I want an equity-index type of return.”

While 6% a year could satisfy other equity investors, Kalscheur said his expectations are much more bullish than that.

“I’m not quite at 10% but pretty close. Certainly not 6%,” he said.

“I know many people have lower expectations because they anticipate the end of this bull market. They’re projecting the GDP to be sub 2%. But we now have a 3% GDP. There’s a huge difference between 1.8% and 3%. If you get those tax cuts and those regulations stripped, you can very easily have lower inflation, lower taxes and a flood of money going into the market.

“I’m a huge bull.”

BofA Merrill Lynch is the agent.

The notes will price and settle in November.

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