Barclays’ buffered dual directional notes on two international ETFs offer alpha, risk mitigation

By Emma Trincal

New York, May 26 – Barclays Bank plc’s 0% buffered dual directional notes due June 13, 2025 linked to the least performing of the iShares MSCI Emerging Markets ETF and the iShares MSCI EAFE ETF give investors a chance to outperform in most market conditions, advisers said. The only downside is the worst-of exposure, they added, since the underliers, which track emerging versus developed markets, are not highly correlated.

The payout at maturity will be par plus 120% of any gain in the lesser performing ETF, according to a 424B2 filed with the Securities and Exchange Commission.

If the lesser performing asset falls by up to 15%, the payout will be par plus the absolute value of the return of that ETF.

Investors will lose 1% for every 1% decline of the lesser performing ETF beyond 15%.

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said the notes are timely.

“We’re in a market with so many unknowns ... it’s nice to see a note that can protect the downside while allowing you to outperform in most scenarios,” he said.

“You can make money if you’re a bull. You can also make money on the downside.”

Prudent investment

The note was well-adapted to current market conditions, he noted.

“When you’re in a bull market, your goal is to outperform the benchmark on the upside. Most people are not too concerned about protecting their investment against downside risk.

“But when come times like these, when you are faced with a number of uncertainties – and I mean the global economy, interest rates, inflation, geopolitical tensions and other factors – you want to be prudent in your allocation decisions,” he said.

Medeiros said he emphasized risk management.

“What a prudent approach means is making more on the upside and losing less on the downside,” he said.

The note, he said, fit such a definition.

“On the upside, it’s going to outperform since you have 120% leverage and no cap.

The non-payment of dividends was not a big factor, he said.

“It’s just a two-year note and those ETFs don’t pay huge dividends.”

Unless the underlying showed a lackluster performance, the 1.2x leverage will offset the “loss” of dividends, he said.

Worst-of

“The terms of this note are attractive,” he said, pointing to the buffered dual directional return on the downside and uncapped leverage on the upside.

Since the dividends are not so high and the term relatively short, some of the factors making the pricing possible included the volatility of each underlier but also the worst-of, he noted. The correlation between the two ETFs is only 0.86, which increases the risk on the downside, allowing the issuer to price better terms.

“You have the worst-of. It’s the tradeoff,” he said.

“But I’m not too concerned about it.

“Both emerging markets and developed markets warrant a small allocation to a portfolio.

“The inherent risk is not really country-specific. It’s region-specific.”

And each of those ETFs is well diversified, he concluded.

Bullish on EM

Steve Doucette, financial adviser at Proctor Financial, also liked the terms of the note.

International stocks in general offer much more attractive valuations than U.S. stocks, he said.

“That note could be a decent growth play. The 1.2 times leverage is not huge, but there is no cap. Having uncapped leverage on a two-year is pretty good,” he said.

The odds of outperforming with the 1.2 times leverage were relatively high even without the dividends, he added.

“On the downside, you can outperform a lot. The ETF is down 15%, you make +15%. You outperform by 30%,” he said.

The dual directional component constituted the most valuable feature of the note, he said.

“You outperform on the downside, and you outperform on the upside. This is why I like those notes,” he said.

Opportunity cost

For investors the main question was whether the exposure to the worst-performing fund was acceptable.

“I like both funds, but I prefer the emerging markets. Chances are that emerging markets are going to be the growth story,” he said.

“Of course, you have political risk, especially with China and Taiwan. But if the economic growth of Asian countries is booming, who cares? There’s always going to be geopolitical risk.”

Doucette said that most of the risk was on the upside, which he identified as “opportunity cost.”

“Here’s my concern: what if emerging markets are up 40% and EAFE only up 10%? Then you’re stuck with a 10% return.

“That could be an issue.

“I would probably try to change the note by eliminating the worst-of and replacing it with a weighted basket.

“It’s something you would have to negotiate with the issuer. I’d have to see how much leverage and buffer I could keep. I’d try to keep the terms as closely as they are now,” he said.

Barclays is the agent.

The notes will price on June 7 and settle on June 12.

The Cusip number is 06745MEG9.

© 2015 Prospect News.
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