Barclays' $35.54 million leveraged bear notes tied to Russell drew top bid for hedging appeal

By Emma Trincal

New York, Sept. 12 - Barclays Bank plc's $35.54 million of 0% Accelerated Return Notes due March 22, 2013 linked to the Russell 2000 index, last week's top offering, surprised some participants because the so-called "bear notes" are not known to be among the most popular products, sources said.

But some said that that we may see more of those.

The benefits of the structure as a hedging tool providing investors with risk diversification was one of the factors driving the size of the deal, according some sources.

Another one may simply be that investors are getting more comfortable using bearish structured notes instead of exchange-traded funds when they seek a short exposure to an index or asset class, another source said.

The payout at maturity was par of $10 plus 3% for every 1% index decline, up to a maximum return of 11.535%, according to a 424B2 filing with the Securities and Exchange Commission. Investors would lose 1% for every 1% gain in the index.

The trade may have originated from a single institutional investor, given its size, an industry source said.

"Maybe it's a hedge fund behind this who wants to hedge a position," he said.

"It's rather trading-oriented. I'm not sure high-net worth investors would do that. If they're bearish, they tend to stay out of the market," he said.

Going mainstream

A structurer said that bear notes may be gaining some traction in a market where bullishness and nervousness often mix.

"The equity markets have been doing well; people may think it's topping," this structurer said.

"Now does it mean people are turning into bears? I don't think so.

"The healthy trend is not that people are getting more bearish. The market is up. Obviously they're not more bearish. But you always have people who are bearish in any given market otherwise nobody would sell anything."

"With this deal, it looks like the bears are open to using structured notes to express their views. That's the interesting trend. And that's reassuring. People are turning to structured notes to express their views, regardless of what their views are. That includes bearish views," he said.

Hedge

Don McCoy, financial adviser at Planners Financial Services, said that the notes were not for investors with a strong bearish bias. The upside is leveraged by a factor of three and capped at 11.5%.

The notes are suitable for those who believe that the Russell 2000 will only decrease moderately, according to the prospectus,

Rather than taking a directional bet, the investor in the product would use it as a hedge, McCoy said.

"This is for the short-term nervous investor who wants a little bit of a hedge but who's not really a bear," he said.

"If you don't want to trigger a lot of capital gains by selling, you can use that as a hedge.

"I can buy this note and get some protection. If the market is up, I lose on a one for one basis but the rest of my portfolio is making money. And if I'm right, if the market is down, I've offset my losses.

"You're capping your gains at 11.5% but you have three times the index. This is more for the slightly pessimistic investor. You'd want a bigger cap if you were really bearish," he said.

Six months

The short duration of the note and its timing may also be part of the successful story, he noted.

"It's a hedging tool for people concerned about what is going to happen within the next six months. There is so much uncertainty coming up between the elections, what will come next from Washington and the fiscal cliff issues everyone hears about so much," he said.

"The risk is to get a massive bull market in the next six months. But if that happens, I wouldn't feel so bad for the rest of your portfolio. If the market is up 15%, you lose 15% here but the rest of your portfolio is doing quite well.

What else is out there?

The structurer said that more investors are turning to structured notes rather than leveraged ETF simply because the notes may be more efficient.

"With leveraged ETF there is a convexity problem," the structurer said.

"The leveraged ETF is usually rebalanced daily. Even if you pick the right direction, you can still lose money because they are structured for day traders not for point-to-point investors. If you are a point-to-point investor and want to get inverse leveraged exposure to something, it makes sense to me to use structured notes. How else are you going to do it?

"Are you going to borrow shares? They are borrowing fees involved and it's not the most efficient way to do it.

"You could use options, you could buy a put. But not everyone is an option trader and what if the market doesn't move? The time decay would kill you."

"Structured notes are efficient. It's SEC-registered. You have limited risk. Even though losing your entire investment seems like a lot, it's still limited compared to losses you can incur when you borrow shares for a short trade," he said.

The notes (Cusip: 06738G191) priced on Sept. 6

Bank of America Merrill Lynch was the agent.

The fee was 1%.

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