Barclays’ buffered SuperTrack notes tied to Russell designed for modest bullish view

By Emma Trincal

New York, April 30 – Barclays Bank plc’s 0% buffered SuperTrack notes due Aug. 8, 2019 linked to the Russell 2000 index target investors who believe the market has reached its peak and seek double-digit returns through leverage, advisers said.

The payout at maturity will be par plus 2.5 times any index gain up to a maximum return of 13% to 15%. The exact cap will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 5% and will be exposed to any losses beyond the buffer.

Toppish market

Carl Kunhardt, wealth adviser at Quest Capital Management, said the notes matched his moderately bullish outlook for the short term.

“I would do it mostly because we don’t expect U.S. equity markets to achieve strong returns over that short period of time,” he said.

Kunhardt bases his market expectations on Mercer Investments’ predictions. The consulting firm anticipates a 4.8% annual growth in U.S. small-caps over the next five years.

If the cap is set at midpoint of the range, or 14%, investors can expect to achieve the maximum result – 11% per year on a compounded basis – with only 4.45% annual increase in the index.

“This would exactly match our current market outlook, which is based on Mercer’s research,” he said.

“Even though there’s nothing in the market that says that current economic activity will not continue, we’re nine years into the bull market so we don’t have very high expectations.”

Buffer

Kunhardt always compares a note to the equivalent long position in equity, which in this case would be an exchange-traded fund on the Russell 2000 index.

“With the note, you’re much better off if the market is slightly bullish because of the leverage,” he said.

On the downside, the 5% buffer gave the advantage to noteholders.

“It’s a tiny buffer, but small-caps don’t pay huge dividends so you end up being better off on the downside as well.”

The iShares Russell 2000 index ETF pays about 1.25% in dividend, which for the 15-month note would represent a 1.55% opportunity cost.

Investing in a low-paying dividend over a short timeframe helps structured notes better compete with ETFs as the opportunity cost induced by the non-payment of dividends lessens, he explained.

Timeframe

Short-term investing however presents its own risks.

“Over the long-term, markets are rational. Short-term, markets are completely emotional and irrational,” he said.

“Trump could send a tweet tomorrow and the market could be down 1,000 points.

“We saw that recently. We’ll probably see it again.

“The question is: will it last? We don’t know.

“But we know that over the long-term this noise is almost always irrelevant.”

Back testing

Michael Kalscheur, financial adviser at Castle Wealth Advisors, analyzed the notes using back testing in order to get a sense of the probabilities of return outcomes for the 15-month period.

Kalscheur has collected data on the Russell 2000 index since 1997. Using 15-month rolling periods, he found the following results:

• The chances for the index to finish down below the 5% buffer are 20%;

• There is a 6.5% chance for a decline between 95% and 100% of the initial price, which is the buffered, protected zone;

•∙The frequency of occurrence for a closing price on the positive side but below the 14% hypothetical cap is 24.5%; and

• The probability for the index to finish above the cap is 49%.

“One out of five times, you’ll be down and break through the buffer. You will still outperform the index. But you will lose money and clients don’t like to lose money,” he said.

“That’s why we like to have 10%, 15% or 20% buffers. We know it means going out four, five or six years. But we prefer it that way.”

Mixed results

The upside was not very appealing either, according to this adviser.

“Almost half of the time you’re giving up something on the upside,” he said.

“Is 14% a bad rate of return? No. I’d take it.

“But statistically speaking, half of the time you’re going to do better with the ETF.”

The buffer however benefited structured notes investors.

“I’m not saying it’s a bad note. It’s just designed for a specific type of investor. Not a huge bull, but rather someone with a very mildly bullish outlook,” he said.

“You don’t expect the market to go up a lot and you’re not totally pessimistic or bearish, that’s the profile.

“If you think the market will be up 4.5% a year then you’ll hit your cap and be in good shape. From that standpoint I can see an argument to be made in favor of this note.”

A GS Finance deal

Another 15-month leveraged capped product linked to the Russell 2000 index is set to price around the same time next month.

GS Finance Corp. plans to price 0% Performance Leveraged Upside Securities due Sept. 5, 2019 linked to the Russell 2000 index, according to an FWP filing with the Securities and Exchange Commission.

The notes are guaranteed by Goldman Sachs Group, Inc.

If the index return is positive, the payout at maturity will be par of $10 plus 300% of the index return capped at par plus 15.3%.

Investors will lose 1% for each 1% decline in the index.

Morgan Stanley Wealth Management will be handling distribution.

The underwriting discount is 2.35%.

Kunhardt preferred the first deal, which carried a 0.5% fee.

“The fee [on the GS Finance note] is way out of the ballpark and the note is without any downside protection,” he said.

“I’m exposed to all the risk and I pay a hefty fee for the leverage. Leverage is all I’m getting. I’m not getting anything else. I don’t think so.”

Comparable stats

Kalscheur agreed about the striking difference in fees. But he looked at the upside for the GS Finance deal.

“The 3x leverage is a little bit better,” he said.

“You have more than an extra percentage point on your cap: 14% versus 15.3%.

Kalscheur reemployed his back testing methodology on this second deal with the following results:

• The chances for the index to finish negative is 26%;

•∙The probability for the index to close between the initial price and the 15.3% cap is 27.5%; and

•∙The probability for the index to finish above the cap is 46.5%.

“It’s a little bit the same idea. Half of the time, I’m going to underperform on the upside although statistically speaking the chances of outperforming here are better on the Goldman deal,” he said.

Cost is relative

“The terms are actually better with the more expensive one,” he added.

“That’s how valuable a buffer is. It’s expensive. It’s going to cost you.”

“Of course, if Goldman had shown a lower fee, the terms would have been much better.

“Morgan Stanley will probably have no problem selling it. It’s a commission sales type of market rather than fee-based market.”

Kalscheur reached the same conclusion as Kunhardt, but the cost was not his main objection.

“We could go with the GS Finance deal. It has more upside potential. But that’s not why we buy structured notes.

“We don’t do it for the leverage. We do it for the downside protection.”

Barclays is the agent on the Barclays deal.

The notes will price on May 4 and settle on May 9.

The Cusip number is 06746X6U2.

Goldman Sachs & Co. is the agent on the GS Finance deal.

The notes are expected to price on May 16.

The Cusip is 36254G515.

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