Barclays’ two offerings of 90% principal-protected notes to appeal to risk-averse investors

By Emma Trincal

New York, June 10 – Barclays Bank plc is planning two separate 90% principal-protected note offerings that advisers said are likely to attract conservative investors.

Both products, each linked to a separate index, offer protection that limits losses to 10%, which is different from the commonly used buffer.

Appetite for these products is likely to result from the protection, the advisers said, but investors should consider whether they are better off with this type of partial protection or a buffer.

In the first deal, Barclays will price 0% equity-linked partial principal at risk securities due June 25, 2021 linked to the Euro Stoxx 50 index, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par of $10 plus 140% of any index gain. If the index declines, investors will receive par plus the index return, subject to a minimum payout of $9 per note.

The second deal, linked to the S&P 500 index, is one year shorter. The structure offers no upside leverage and has a cap of 200% of par. The minimum payment at maturity is the same at 90% of par.

Inverse of a buffer

“This type of protection is intriguing,” said Michael Kalscheur, financial adviser at Castle Wealth Advisors.

“It’s the inverse of the traditional buffer. It’s the other 90% you’re protected on.

“You know ahead of time that you can lose some money, but you know it can’t be more than 10%.

“Normally, clients are worried about really bad markets like the 40% decline in 2008. That’s the kind of drawdown nobody can handle.

“The protection here is designed to address that type of fear.”

Kalscheur said that almost all types of downside protection mechanisms fall under the category of buffers or barriers. The 90% protection is less common, he said.

“People are much more accustomed to buffers. For instance, with a 10% buffer, your first 10% are protected. If the market is down 15%, you only lose 5%. Most people like that,” he said.

“Here, the chances of losing money compared to a buffer are higher because you will lose your first dollars on day one. But the risk is capped, which limits the dollar amount of losses.

“I can definitely see why a client would like something like this. You don’t have 100% protection, but you do have 90% guaranteed. It’s the opposite of a buffer where you can lose up to 90%.”

Dividends and leverage

Comparing the two notes is not easy because the structures are so similar, sources noted.

Tom Balcom, founder of 1650 Wealth Management, however, said that he prefers the notes linked to the Euro Stoxx 50 index.

“The Euro Stoxx one is seven years versus six years, so just a bit longer. On the other hand, it has 1.4 times leverage and no cap,” he said.

The difference in leverage may be justified by the yield differential between the two benchmarks, he observed.

The Euro Stoxx 50 index has a 2.7% dividend yield versus 1.8% for the S&P 500.

“With the S&P deal, you lose the dividends because there is no leverage to compensate you for that. If the market does not surge, you’re not going to miss out a lot. But if we have a strong rally, you would see the difference.”

Investors in structured notes are not entitled to receive dividend payments as would be a shareholder.

“The loss of dividends has a higher cost with the Euro Stoxx deal because you’re missing on a higher yield. Also you’re missing on an extra year of payment.

“That’s why you have the leverage, which should compensate you for that.”

The 200% cap with no leverage means that investors would “hit the cap” with a 12% annualized rate of return.

“If you expect the S&P to be up by more than 12% a year over the next six years, don’t buy the notes. You would be capped out,” he said.

“This note is geared to a client who is concerned about a pullback. It’s more for a bearish investor. If the S&P is down 20%, they’ll be down 10% and be happy to have outperformed the index.”

Euro trend

If he had to choose one deal versus the other, Balcom said he would pick the uncapped notes.

“I like the no-cap, and I like the leverage offered even though the notes are longer. So between the two offerings, I prefer the one on the Euro Stoxx,” he said.

“Besides, I am pretty bullish on European equity as there is a lot of optimism in the market around the European Central Bank,” he said.

The ECB announced last week a rate cut and further easing measures, which gave a boost to the Euro Stoxx 50 index, he noted.

However, he said he would not consider either of the two deals.

“Both deals are rather long in duration. You have interest rate risk. As interest rates rise, the underlying value of the notes will be negatively affected by that,” he said.

S&P 500

Kalscheur, on the other hand, said he would choose the deal linked to the S&P 500 index, in part because of the benchmark.

“The Euro Stoxx deal is much better at first glance. The 1.4 times leverage with no cap is pretty compelling,” he said.

“And usually, the no-cap feature is key. But in the case of the S&P notes, the cap is less of an issue. It is such a high cap, it doesn’t really hurt you that much.”

He offered the following reasoning: an investor in the six-year notes linked to the S&P 500 would need to see his initial investment double before reaching the cap, which would represent a 12% annual rate of return over the period.

“It seems like a pretty high return, some quite ambitious expectation,” he said.

“Normally, my biggest concern with caps is that they limit your return short-term. But here, your cap is 12% a year.

“Because of the long timeline and the very high cap, this 200% cap is not a deal breaker. If you were to tell me that over the next six years, I would be making over 12% a year, I would say that’s pretty good.”

Compelling terms

For Kalscheur, the difference between the two products boils down to the choice of the underlying asset class.

“The deals are both compelling. I can find four or five reasons to like any of the two,” he said.

“I like the leverage on the Euro Stoxx one.

“I like the S&P better as an index

“I like the shorter term on the S&P, but the fee is the same, so it makes the Euro Stoxx deal cheaper.”

The fee on each deal is 3.5%, according to the prospectuses.

“A 3.5% fee is a lot of money, but spread over six or seven years, it’s about 60, 50 basis points, which is very competitive,” he added.

“If I had to pick one, I would go with the S&P because of the index.

“But both deals are attractive as they both offer good terms, well-known benchmarks and competitive pricing.”

Kalscheur said that investors would probably choose to invest in those products because of the type of protection being offered.

“These notes would appeal to conservative investors due to the 90% principal protection,” he said.

But he warned investors about some risks.

Big losses only

The 90% principal protection should be carefully evaluated versus a 10% buffer, he said, as the value of the protection depends on the amount of losses investors might expect.

“The 90% protection should not be for everyone,” he said.

“Unlike a buffer, you’re taking on the first losses. Do you want to cap your losses at 10% even though it means you have a greater chance of losing money, or do you want to reduce the odds of losing money while taking the risk of losing more?”

For Kalscheur, the buffer may make more sense over longer durations as time itself, in his view, offers some level of safety.

“Over a six-, seven-year time horizon, you wonder if you’re not paying too much for the 90% protection versus a 10% buffer. Statistically speaking, the longer you go, the smaller buffer you should demand,” he said.

“I’m not a fan of a 10% buffer for a one-year term, when you can have huge swings in the market. I’m not even a fan of it for a three-year. But over a six- or seven-year period, I think a 10% buffer is acceptable.”

Kalscheur said that investors in the 90% principal-protected notes would be likely to have a pessimistic outlook on the market, expecting high losses.

“The market would have to drop by 20% in six years for a 10% buffer to lose its edge over the 90% protection,” he said.

With a 20% market decline, the 10% buffer would create a 10% loss, equal to that of the partially protected note. Beyond that, investors are better off with the 90% protection.

Caveat

“I can see why some clients may prefer this type of guarantee. But it comes at a cost. Here is my caveat. For the client who is worried about Armageddon, why not go for the full 100% principal protection?” he said.

“If you worry that much about the market, why take the chance of losing 10% up front?

“It’s true that the terms of a 100% principal-protected note would be less attractive than those terms. I’ve never seen a leveraged, no-cap note or CD in a fully principal-protected format.

“But taking the first losses has a cost too, and you need to assess your own risk tolerance. Just because you want to cap the losses at 10% does not mean you cut your chances of losing 10%. Quite the opposite.

“A lot of it is psychological. A lot of people will be drawn to this type of protection as it tells you in advance how much you can lose. But sometimes, a buffer is the way to go.”

Barclays is the agent for both offerings. Morgan Stanley Wealth Management will handle distribution.

The offerings are expected to price June 20.

The Cusip number is 06742W752 for the notes linked to the Euro Stoxx 50 and 06742W737 for the notes linked to the S&P 500.

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