Barclays links Super Track notes to S&P 500; investors seek leverage, protection: adviser

By Kenneth Lim

Boston, May 18 - Simple index trackers that are neither leveraged nor offer full principal protection may not be as attractive in the current market as investors speculate about a recovery, an investment adviser said.

Barclays Bank plc on Monday launched a series of planned buffered Super Track notes due May 26, 2011 linked to the S&P 500 index.

At maturity, the notes will pay par plus any gain in the index, subject to a maximum total payout of 140% to 150% of the principal. The exact cap will be set at pricing.

If the index finishes flat or falls by no more than 20%, investors will receive par. Investors will lose 1% for every 1% that the index declines beyond 20%.

Cautious optimism

The volatility of the U.S. stock markets has been dropping in the past few weeks and the options markets are implying volatility to stay low, which suggests that equities could be reaching a bottom, the adviser said.

But it is still too soon to know if recent rallies mark the end of the market's drop, which began in 2007, said the adviser.

"This is as close to your textbook definition of cautiously optimistic as you can get," the adviser said.

The mix of hope about the future and concern that the hope may be unfounded suggests that investors will want some protection against either outcome, the adviser said.

"If you think there's going to be a recovery and you want to get the best of it, then you want some kind of leveraged upside so that your returns are higher," the adviser said. "If you think the market could fall further then you want to have principal protection. At this point in time I think many investors are a little afraid to commit to either outlook for certain, so ideally they'd like to have both, but if they can't get both then you have to give them at least one. This [Barclays product] doesn't have either."

Future of protection

The adviser thinks that even if the markets pick up, demand for principal protection will not decline significantly because the market crisis has set a new level of risk tolerance among investors.

"Even if the market picks up, you won't be able to sell another mortgage-backed CDO," the adviser said. "I think the risk appetite just isn't there anymore. Investors still want to make money, but they're a lot more conscious now about the risks and they're not going to put everything on the line just for those few hundred basis points."

If the equity markets improve, volatility is also likely to ease, and the price of providing principal protection could also go down, the adviser said. That means issuers will be able to offer more attractive terms on principal protected products.

"I think they'll be even more interesting," the adviser said.

A structured products distributor agreed that demand for principal protection will remain strong but said that the impact of stronger markets will be seen most in non-principal protected products.

"It's not will we sell fewer principal protected products, but we'll definitely sell more principal-at-risk products," the adviser said. "There will be greater allocations from less risk-averse investors, and in many portfolios it may make sense to invest in some principal-at-risk products to potentially improve the returns on the portfolio.

"We're not telling people to buy nothing but principal-at-risk or nothing but principal protection. As with all structured products, every product has certain features that can allow it to fulfill a certain role in a balanced portfolio, and we're constantly working with the investors' advisers and broker-dealers to help them figure out what that is."

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