Barclays’ dual directional notes tied to oil ETFs generate opposite views from buysiders

By Emma Trincal

New York, Oct. 17 – Barclays Bank plc’s 0% dual directional notes due Oct. 22, 2021 linked to the lesser performing of the VanEck Vectors Oil Services exchange-traded fund and the SPDR S&P Oil & Gas Exploration & Production exchange-traded fund is a very good or not so good deal depending on whom you ask.

The notes designed for an investor expecting a recovery in the energy sector offered a worst-of payoff through a leveraged and capped exposure with barrier protection and absolute return. It generated opposite responses from financial advisers.

If the final share price of the lesser-performing ETF is greater than or equal to its initial share price, the payout at maturity will be par plus 1.2 times the return of the lesser-performing ETF, subject to a maximum return of 75%, according to a 424B2 filing with the Securities and Exchange Commission.

If the final share price of the lesser-performing ETF is less than its initial share price but greater than or equal to its barrier share price, 65% of its initial share price, the payout will be par plus the absolute value of the lesser-performing ETF’s return.

If the final share price of the lesser-performing ETF is less than its barrier share price, investors will lose 1% for every 1% that the lesser-performing ETF’s final share price is below its initial share price.

Underlying

Jerry Verseput, president of Veripax Financial Management, who invests in worst-of securities, said this one was “really interesting.”

He liked the choice of the two underlying funds as well as the structure.

“My initial reaction is: I’m going to call Barclays,” he said.

He first analyzed the correlation between the two energy ETFs both on the energy space.

“You want the two assets to be highly correlated in a worst-of. And when you look at the two charts they’re exactly the same. That’s a very good thing,” he said.

“It’s interesting because you’re dealing with two different spaces in the energy sector that operate at different levels. You have the upstream or exploratory and the midstream, which is pipelines and services,” he said, referring to the SPDR S&P Oil & Gas Exploration & Production ETF and the VanEck Vectors Oil Services ETF respectively, which he called after their ticker symbols “XOP” and “OIH.”

Protection

Using technical analysis, Verseput said he felt very confident about the 35% contingent protection.

“XOP is just below the lows that were set in 2016 when oil collapsed. That’s a pretty safe floor,” he said.

“OIH has a little bit more room because it’s at an even lower point.

“If you believe at all in energy recovery, it’s an excellent play.”

Using equity funds in energy was also beneficial to investors compared to a direct commodity play on oil.

“Oil ETFs are constantly rolling futures contracts while when you have equity funds like this you don’t have contango degradation,” he said.

Contango refers to the cost of rolling futures contracts when the futures curve is positively slopped, in other words when spot prices are lower than longer-dated contracts, which generates a negative roll yield.

Cap

Out of the two upside elements of the structure – the leverage and the cap – the potential 15% a year on a compounded basis was the most compelling, according to Verseput.

“Any client who complains about getting 75% over the next four years I will fire them,” he said.

“When you look back it’s always better. You could have had more upside. You may not have needed that much protection. But looking backward has no risk.

“Looking forward on the other hand involves taking risks and accepting tradeoffs. If a client doesn’t understand that, they don’t understand what I’m trying to do.”

The purpose of the notes was to “cap the return for a substantial protection” on the downside, he added.

“I think they’re doing just that. It’s a very fair tradeoff.”

Asked if the four-year tenor was not also part of the “tradeoff” as some investors dislike holding a note for a long time, he said that: “As a structured note, you can sell that any day. Four years is not a problem. I can sell a structured note faster than I can sell a mutual fund.”

The leverage factor of 1.2 met its goal of partially offsetting the “loss of dividends,” he said.

“You’re not giving up much dividend. But the 120% of leverage makes some of that,” he said.

The SPDR fund has a dividend yield of 0.86%. The VanEck Vectors ETF yields 1.78%.

Not so great

Steven Foldes, vice-chairman of Evensky & Katz / Foldes Financial Wealth Management, held the opposite view.

The 75% cap was “not a bad cap” but still could have been higher based on the overall risk-adjusted return profile of the product, he said.

“The upside is capped and it’s a very volatile asset class. We don’t think exchanging the capped upside for a 35% barrier is enough to make this worthwhile,” he said.

“I’m giving up a lot on the upside and while 35% in contingent protection is a lot it can be easily breached because of the volatility.”

The dual directional feature may not be of use.

“The absolute return is a nice thing, but if you go through the 35% barrier you’re not going to benefit from it. And then you’re going to lose dollar for dollar since it’s a barrier not a buffer.”

Investors in the notes would have to be neither too bullish nor too bearish to find the deal attractive.

“Any structured note expresses a view. But what you’re expressing here is a moderate view based upon inherently volatile ETFs,” he said.

Foldes said he does not like using worst-of in general, finding those products too challenging to explain to clients.

For instance, he said, a noteholder may earn 34% if the worst-performing fund declines by the same amount. But if its price drops 36%, the client would lose 36%.

“It’s a client-sensitivity issue. Not only do you have to spend a lot of time explaining the product...But the client may end up being very unhappy.”

Barclays is the agent.

The notes will price on Thursday.

The Cusip number is 06744CE31.

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