Barclays’ PLUS linked to oil & gas exploration & production ETF offer good value but high risk

By Emma Trincal

New York, Dec. 11 – Barclays Bank plc’s 0% Performance Leveraged Upside Securities due Dec. 16, 2019 linked to the SPDR S&P Oil & Gas Exploration & Production exchange-traded fund give investors the potential to outperform the underlying fund, but the risk is much higher than average, said Tim Vile, structured product analyst at Future Value Consultants.

The payout at maturity will be par of $10 plus 300% of any gain in the fund, up to a maximum return that is expected to be at least 93.15% and will be set at pricing. Investors will be fully exposed to any decline in the fund, according to an FWP filing with the Securities and Exchange Commission.

“This note offers an enticing return with three times the upside and a 93% cap, which is quite high,” said Vile.

“However, this is a very volatile ETF given the current sell-off in oil.”

The implied volatility of the ETF is 47% versus 16% for the S&P 500 index.

The underlying fund is an equity index. It tracks the performance of the S&P Oil & Gas Exploration & Production Select Industry index, a sub-industry portion of the S&P Total Markets index. The fund is highly correlated to oil prices as a result.

“The combination of a volatile underlying fund and the lack of any downside protection obviously elevate the risk of this product,” said Vile.

Upside first

“This is a return enhancement note. The focus is not on reducing risk. It’s obviously a note for bulls only.”

The 93.15% cap with three-times upside leverage over four years gives investors the potential to earn nearly 18% per year on a compounded basis, he said.

“This is not a punishing cap, but you still need to look at the volatility and the chart of the fund in order to see if 18% is enough to compensate you for the risk you’re taking. Also you have to take into account the four-year holding period, which may also have an impact on the return.

“Is a four-year riskier than a short maturity? Given that oil has recently hit new lows, one can argue that a long tenor may be less risky than a shorter trade as it may give the ETF enough time to recover. At the same time, a similar pullback in the commodity price can easily happen again several times during this period.”

No protection

The ETF has seen wide price fluctuations. From its March 2009 low to its peak in June 2014, the share price more than tripled. Since then, however, the value of the fund dropped 61%.

Vile said that deals with high leverage tend to come with a lower cap. The four-year duration could also facilitate the pricing of a buffer or a barrier.

“In this structure, the issuer eliminated the downside protection and instead focused on maximizing the returns,” he said.

“The underlying is volatile, making the cost of the options pricey. It would have been nearly impossible to offer some protection with the same terms on the upside.

“It makes for a very bullish play likely to appeal to an investor who is comfortable with the higher risk profile of this note.”

Riskmap

Future Value Consultants calculates the market risk and the credit risk of any product it rates. It then adds the two components to generate the “riskmap,” which measures on a scale of zero to 10 the risk associated with a product with 10 as the highest level of risk possible.

The notes have a 7.72 market riskmap versus an average of 2.82 for the product type, according to the firm’s research report on the product.

“The market risk is very high. That’s not surprising. We have the high volatility, and there is no barrier, no buffer,” he said.

The credit riskmap is 0.52, compared with the average of 0.42 for the leveraged return product category.

“Four years for a leveraged note is above average. You get credit risk exposure for a longer time than average. The high credit risk is almost certainly not attributable to this issuer,” he said.

Barclays’ five-year credit default swap rates are 62 basis points, according to Markit. In comparison, the spreads for most U.S. banks are in a 76 bps to 87 bps range.

Return score

The return score, which measures the risk-adjusted return of a note on a scale of zero to 10, is computed based on the best of five market scenarios. In this case, the optimum scenario would be bullish.

At 6.28, the return score is lower than the 7.11 average for the product type.

“It’s essentially the riskmap that pulls down the return score,” he said.

“It’s actually a reasonable return score given how high the riskmap is. The leverage and the 93% cap helped a lot.”

Value

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 6.40 price score while the average for the product type is 5.97.

“The product offers good value to investors,” he said.

“The four-year duration definitely helps. The fees, which we calculate on an annualized basis, are spread over a longer period of time,” he said.

“Also the structure itself suggests the issuer spent a fair amount of money on the assets, especially in buying the calls for the leverage. With a barrier or a buffer, this note would have scored even better on the price scale.”

Overall score

The report showed an overall score of 6.34 versus an average of 6.54 for similar products and 7.36 for all products.

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

“The return score is low, but the price score is above average. We end up with a reasonable overall score,” he said.

“This is an interesting note. A lot of things could happen. Investors can earn a lot or lose a lot.

“If you’re bullish, it’s a very good product. You are betting on the recovery of the energy sector, you believe that oil may have hit the bottom.

“This is definitely not for the risk-averse investor. This is a conviction trade.”

Barclays is the agent. Morgan Stanley Wealth Management is a dealer.

The notes will price Dec. 11.

The Cusip number is 06743T543.

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