Barclays' performance securities tied to two indexes a bet on V-shaped recovery, adviser says

By Emma Trincal

New York, Aug. 18 - Barclays Bank plc's upcoming 0% performance securities with contingent protection due Aug. 31, 2015 linked to a basket of indexes should appeal to long-term investors seeking to gain exposure to small- and mid-cap stocks in a bullish bet on the economy while offering an attractive downside mechanism, sources said.

The basket includes the S&P MidCap 400 index with an 80% weight and the S&P SmallCap 600 index with a 20% weight, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par of $10 plus 104% to 111% of any basket gain. The exact participation rate will be set at pricing.

Investors will receive par if the basket falls by 50% or less. If the basket declines by more than 50%, investors will be fully exposed to the decline from the initial level.

Appealing structure

While the 104% to 111% participation rate is attractive, it's mostly on the downside that the terms are appealing, a sellsider noted.

"I think this is not a bad deal. The 50% barrier is pretty generous even for a five-year," this sellsider said.

The trigger level, which is 50% of the basket's initial price, is only observed once, at maturity, and not anytime during the term, he noted, adding that it was a positive aspect of the structure.

"If it was during the life of the notes or during a series of observation dates, the barrier could have been breached very easily especially on a five-year. But this gives more protection," he said.

However, the barrier differs from a buffer, according to the prospectus.

If the basket level ends below the trigger, the contingent protection is lost and investors are exposed to any decline in the underlying, losing 1% of capital for every 1% decline in the basket, the prospectus stated.

"I still think that this downside protection feature is appealing for someone who wants exposure to small- or mid-cap stocks," the sellsider said. "Obviously though, you're paying the 50% downside protection by being locked in for five years."

It's the economy

Bill Thatcher, financial adviser at Hammond Associates, said that both indexes have outperformed the S&P 500 over the past 12 months.

The S&P MidCap 400 index has gained 18% and the S&P SmallCap 600 index has gone up 14% while the S&P 500 has increased by 10.5% during the past year.

Thatcher said that the rationale for investing in the notes depends on how investors gauge the future performance of mid-caps and small-cap stocks versus large-caps. The relationship between the two groups of stocks will depend on the shape of the economic recovery, he said.

"We think that in a sluggish economic environment, large-cap stocks that pay dividends are going to do much better than small- and mid-cap stocks," said Thatcher.

"So these notes represent for us a bet that's completely at odds with our own company's bet."

Thatcher said that he was moving his clients' money out of small- or mid-size stocks into large-cap stocks on the view that the economy will remain weak for some time.

"When the economic activity slows, people are still going to brush their teeth, they're still going to buy food or medicine," he said.

"That's why we are looking at big companies like Pfizer and Johnson & Johnson that are still paying dividends."

Thatcher said that the deal would make sense for investors very bullish on the economy, which is not his view.

"Do you think that the economy will come roaring back within five years? I don't see it. But if that's your view, then yes, that's when small-cap and mid-cap stocks outperform large caps," he said.

"This deal is a bet on the economy recovering quickly. It's a bet on a V-shaped recovery."

The securities (Cusip: 06740L253) will price on Aug. 24 and settle on Aug. 31.

UBS Financial Services Inc. and Barclays Capital Inc. are the underwriters.

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