Barclays’ 14-month bear leveraged notes linked to S&P 500 reintroduce out-of-fashion trade

By Emma Trincal

New York, May 23 – Barclays Bank plc’s upcoming 0% bear Accelerated Return Notes due July 2017 linked to the S&P 500 index may surprise financial advisers as the so-called “bear notes” are a rare species.

It’s not that investors avoid taking bearish bets, but they usually tend to avoid directional bets on the downside.

Recent supply has shown increased bids on dual directional products or digital notes with a return triggered below par. But such products are designed to give investors a chance to monetize both upward and downward market moves. Bear notes that only pay when the market drops are rare, according to data compiled by Prospect News.

“I’m sort of intrigued by it,” said Steven Foldes, vice-chairman of Evensky & Katz/Foldes Financial Wealth Management.

“This is not something I see every day.”

The payout at maturity will be par of $10 plus triple the absolute value of any index decline, up to a maximum return of 10% to 14%. The exact cap will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will lose 1% for every 1% gain in the index.

BofA Merrill Lynch is the agent.

Short term

Carl Kunhardt, wealth adviser at Quest Capital Management, said he likes the notes as a short-term hedge.

“I would never describe myself as a bear. You would be a fool to bet against the U.S. beyond the very short term,” he said.

“But I do like the term of the notes. I would never consider a contrarian bet over 18 months. But 14 months is a good length. I’m not particularly optimistic on the short term.”

Kunhardt said he also felt comfortable with the underlying benchmark.

“I like indices that get followed by a gazillion people. You don’t get surprised about your returns as you may be with other lesser-known benchmarks.”

Not many

While he has seen bear notes before, Kunhardt said that this one is the first in a long time.

Pricing of purely bearish notes have not been reported on the SEC website so far this year, according to data compiled by Prospect News.

In March, Deutsche Bank AG, London Branch planned to issue six-month bearish buffered return enhanced notes linked to the performance of WTI crude oil futures contracts with JPMorgan acting as the distributor. But the pricing, which was expected to take place on March 18, has not been reported.

Investors tend to dislike betting against the market, said Kunhardt. But the Barclays bear notes could be a valuable risk mitigation tool for an equity portfolio, he noted.

Hedge

“What I like about those notes is that it’s so hedgeable,” he said.

“You get one-to-one exposure on the upside with unlimited losses. But if I pair that with an S&P ETF, I have no exposure on the upside.

“If the index is up 10%, I lose 10% from my note but I’m up 10% on my ETF. It’s a wash.

“However, if it’s down 10%, then I lose 10% from the long-only position but I’m going to cap out on the downside. I made 5%.”

This strategy designed to limit risk could only fail if the market declines by too much, exceeding the cap.

As the cap limits the bearish-induced positive return, investors should only anticipate a moderate market decline, warned the prospectus.

The notes would be an efficient hedge in a correction scenario but an incomplete one in a bear market, said Kunhardt.

“My only risk is if I lose more on the ETF than the cap will allow me to earn on the downside,” he said.

Strategy

“If you just look at the note itself, it’s an interesting note, but that’s it. But it becomes really attractive if you look at it as a strategy,” he said.

“My only risk is the S&P dropping more than the cap, but I’m still making money up to that point. So I get something.”

In an uncertain market environment when buying protection can be expensive, the note offers an “easy” alternative to options.

“I don’t have to buy a put. It’s less expensive.”

Too often, investors remain passive instead of controlling risk as they try to time the market.

“Whatever your view of the market is, you know that the market is always going to go up and going to go down.

“Instead of trying to figure out where the market is going, why not try and make money out of its moves?”

Not bearish

Other advisers have a different investment style and would prefer making a profit from their bet when they are right. Foldes said the notes do not offer a satisfying risk-adjusted return for a bearish investor.

While “intrigued” by the notes, he said that he is not impressed by the terms.

“The fact that the product is unusual is OK. I have no problem with that. And the fact that it’s bearish is OK too, although I’m not bearish on the market over the next 14 months. But it’s the terms that I don’t like,” he said.

Foldes said that the S&P 500 has already been trading “relatively flat” over the past two years, which may suggest a possible rebound. The benchmark has gained slightly more than 5% since May 2014.

“Once the elections are behind us, hopefully some of the clouds over the market will have lifted. So we’re not bearish,” he said.

But even if he held a bearish view, Foldes said he would not consider the notes.

Limited return

“If you’re bearish, you’re not seeing a lot of potential gains. The cap is quite modest. You don’t participate in that significant decline,” he said.

For bears, having a leverage factor of three is “always nice,” but not with a cap as “low” as 10% to 14%, he added.

“If you’re right, the cap doesn’t let you participate.

“If you’re wrong and the market rallies, the idea of losing one to one on the upside is not attractive either.

“It’s not a good participation in a down market. And if we have some upside, you can really get unhappy results.”

Narrow hedge

Foldes took a directional approach on the investment. But even as a protection for a long portfolio, he would not use the notes and for the same reason.

“If you’re doing it as a hedge, it’s not a significant hedge. It only protects you 10% to 14% on the downside. If you’re wrong on the direction, you lose one for one.”

A way to “redo” the notes would be to decrease the leverage in order to increase the cap.

“You’d get more participation in that downside move than just 10% to 14%. You may only get 1.5 times leverage, but at least you get more participation.”

The notes will price in May and settle in June.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.