Barclays Bank’s buffered notes on S&P 500 index seen as a bet on the economy

By Emma Trincal

New York, Dec. 17 – Barclays Bank plc’s 0% buffered notes due December 2020 linked to the S&P 500 index offer an attractive structure, buysiders said. But they struggled with the timing as fears of a global recession are mounting.

If the index return is greater than zero, the payout at maturity will be par plus the index gain capped at par plus 16% to 22%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index declines by up to 15%, the payout will be par.

Otherwise, investors will lose 1% for each 1% decline beyond the 15% buffer.

The risk-adjusted return of the notes fit the moderately bullish view of one adviser.

“I would perhaps consider it,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

“First, it’s on an asset class I’m always going to be invested in. No matter what happens, I’ll always have a U.S. large-cap allocation in my portfolio,” he said.

But the limited upside – the cap is between 8% and 11% a year – was also aligned with his own market outlook for the period.

Buffer

“That’s a normal market return. I don’t expect anything more over the next two years,” he said.

Kunhardt said he always prefers to have a buffer on the downside even if his outlook is bullish or neutral.

“If you’re concerned about the economy, 15% is great. I don’t share the concerns. But it’s always good to have,” he said.

Economic growth

Kunhardt said he is not bearish over the next two years due to his positive view of economic fundamentals.

“The market is a child of the economy. And this economy is very strong,” he said.

“Unemployment is at record lows, participation rate in the labor market at very high levels, GDP is projected to be 4%, and corporate profits are expected to stay up. I don’t see any risk of a recession short term.”

Trade, inflation

Still the potential for further trade tensions between the United States and China is always on any investor’s mind.

But for Kunhardt, trade war headlines are overblown.

“While I’m concerned because trade wars are never won...everyone loses in a trade war, I don’t think [president Donald Trump] is getting us into one. He already had agreements with Europe, Mexico and Canada. I think he’s just positioning.”

In addition, the economy is at no risk of “overheating” at this point in time.

“It’s been such a muted recovery since 2009 that we’ve maintained that sort of lukewarm temperature. I don’t see any signs of inflation at all,” he said.

Elections year

Based on this view, the notes offered an ideal structure, he said.

“Here is something that gives me exposure to an asset class I need to have exposure to anyway. I get that exposure up to a cap that meets or exceeds my expectations and it gives me some protection on the downside.

“What’s not to like?” he said.

Asked if he was comfortable with the tenor – the notes mature in a presidential election year – his answer was confident.

“Election years are always volatile years. But they don’t usually end up being negative.

“Even if it was a down year, that’s when the 15% buffer comes into play,” he said.

Potential to outperform

When assessing a note, Kunhardt said he compares the payout with the underlying index.

“Always look at what this note is written on,” he said.

“You have a 15% buffer. If the market is down at maturity, you can’t do any worse than the index. With a buffer you’ll always outperform a long position.”

The only “risk,” for this adviser was to underperform in a bullish market if the index price was to exceed the cap, a scenario he said was unlikely.

“This note only cost me if the market returns more than 16% to 22% on the upside. That’s the only real risk.”

Structure is fine

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said he liked the structure but was preoccupied with the term of the notes.

“The structure is OK. It has a 15% buffer, which is good on a short-term note,” he said.

“If you have to have a protection, it’s better to have it on a two-year than on a five-year. A two-year term is the period of time you’re most likely to use it.”

The upside cap of 16% to 22%, which is 8% to 11% a year, was “not bad” either, he noted.

“It’s not great but I wouldn’t dismiss it out of hand. It’s pushing to double-digit.

And yet, Kalscheur said he was not particularly interested in the notes.

“I don’t have an issue with the structure. My problem is the timing,” he said.

Timing is everything

Since the market correction which began in early October, several financial advisers have expressed concerns with timing and liquidity, according to prior interviews by Prospect News. A “good structure” with the right underlying is no longer enough to lead buysiders to buy a note.

“This is one of those where I’m sort of following my own personal intuition and I know I could be wrong,” he said.

“But the market has always surprised me. I guess I wouldn’t want to tie my money up for two years if I’m wrong.”

No recession in sight

Kalscheur’s view was relatively bullish but only for the very short-term.

“There is a lot going on right now. We’re in a correction. The market is already down 10%. Do I think it’s going to be down another 15% in two years? Not really,” he said.

“If we were back in August when everyone was euphoric with the rally, I would say, time to buy some protection.

“But if you think that the market after a 10% drop is going to drop another 15%, then you’re talking recession levels.

“I just don’t see it. The economy is still very strong. I can’t imagine a recession that would justify the buffer.”

Kalscheur admitted that the cap was limiting in his view. But if he was wrong, if the market was to fall into a recession in 2019 or 2020, the notes would be even less attractive even with the buffer.

Liquidity

“We are at a time when the market could turn. My personal view is that the bulk of the returns are going to be made in the next 12 months. So I’d rather buy the index. I could get the uncapped exposure with full liquidity. In fact, I could get a leveraged ETF. I don’t think I need to protect the downside over that short period of time.

“But if I’m wrong, I can get out.

“Too many things are going on right now. Either stay liquid or buy a five-year note. A two-year term is a bit treacherous,” he said.

BofA Merrill Lynch is the agent.

The notes will price in December.

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