Barclays’ $8.44 million leveraged notes on EAFE ETF offer bullish bet on international markets

By Emma Trincal

New York, July 9 – Barclays Bank plc’s $8.44 million of 0% buffered SuperTrack notes due March 18, 2022 linked to the iShares MSCI EAFE ETF should have seen its tenor extended to allow for a more defensive or bullish view on the underlying asset class, advisers said.

The payout at maturity will be par plus 3 times any ETF gain up to an 18.5% maximum return, according to a 424B2 filing with the Securities and Exchange Commission.

If the ETF falls by up to 10%, the payout will be par.

Otherwise, investors will lose 1.1111% for every 1% decline beyond 10%.

Performance gap

The underlying tracks the performance of developed countries excluding the United States and Canada.

“This ETF has been underperforming the U.S. for a long time,” said Steve Doucette, financial adviser at Proctor Financial.

“We’ve seen some big jumps lately on good days. The EFA has been up but not quite as much as the EEM.

“Both asset classes have been underperforming. They’re undervalued compared to the S&P 500.”

Doucette was referring to the iShares MSCI EAFE ETF and the iShares Emerging Markets fund, both listed on the NYSE Arca under the “EFA” and “EEM” tickers, respectively.

Some analysts and value investors have noted the divergence between U.S. and international stocks.

But while in theory the gap between international and domestic stocks should narrow, it has not been the case so far.

“If you’re bullish you can expect a reversion to levels closer to parity with the U.S.,” he said.

“But is it a good entry time?

“The U.S. is the top performing market in the world. Are we going to see some asset class rotation?

The iShares MSCI EAFE ETF is down more than 11% year to date. The S&P 500 index has lost only 2.5% during that time.

Upside

The structure, he said, offers attractive terms.

“If this index is up, you can be capped out, but 10% a year is not a bad return,” he said.

“In a range bound market you’re trying to capitalize on that leverage. Three times is a neat multiple.”

The advantage of a high leverage factor is that maximizing the return may not require a steep growth in the underlying price.

Investors in the notes will receive a maximum annualized return of 10.2% on a compounded basis provided the ETF rises by at least 3.85% a year.

“It does get you to 10% fairly fast. You can outperform in a range bound market,” he said.

Geared downside

Finally, Doucette said he liked geared buffers as they significantly improve terms while not penalizing investors much compared to a straight buffer.

He offered the following example.

If the ETF finishes down 35%, investors will lose 27.77% due to the notes’ downside gearing instead of losing 25% with a regular buffer of the same size.

“Does it make a real difference on the downside? 2.75%? I don’t think so. And a 35% drop is the type of bear market we had back in February and March, which is not very typical,” he said.

While the prospectus warns that investors may lose up to 100% of the value of their principal with the geared buffer, the price decline would have to near 100% to achieve such outcome, he added.

“Worst case scenario? You lose 100% instead of losing 90%. Big deal!”

He gave an “extreme and catastrophic” example based on a hypothetical scenario:

“Market is down 99%, you lose 98.88% with this one instead of losing 89% with the normal buffer. OK, so you’re better off with the straight buffer by 10 percentage points. But if it happens, you’ll have plenty of other things to worry about,” he said.

In more common sell-offs and even in severe bear markets, investors in geared buffered notes will not encounter losses significantly greater, he said.

“Whether you use a buffer or a geared buffer, your losses are going to be pretty similar unless there’s a huge drawdown,” he said.

“In both cases, you’re still going to outperform the index on the downside, which will never happen with a barrier once it’s breached.

“Honestly, I don’t understand why so many advisers are spooked by those geared buffers.

“They do make a difference on the upside. You get much better terms and you’re not giving up much.”

Term, cap

Regarding the one-year and nine-month tenor, Doucette said: “That’s the hard one.

“Where are we going to be in two years with this coronavirus, earnings, the economy, the travel, the entertainment industries?”

To reduce some of the uncertainty and enhance the upside, he would probably modify the structure.

“I’d probably make it longer and increase the cap.

“If it’s up 40% in the next two years, you don’t want to be capped out.

“After all, we’re up 45% since March.”

Modest gains

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said the payout was appropriate for investors having limited expectations on the underlying.

“If you anticipate modest growth, the 3x leverage is an incentive as it really helps enhance the return,” he said.

Medeiros said he does not have a very bullish view on the fund.

“These countries are more vulnerable in the pandemic environment. I don’t think they have the same ability as we do to continue to grow their economies.

“We’ll recover faster. The U.S. is a much more diversified economy,” he said.

Length, buffer

Medeiros would also extend the note duration, not for the upside but to increase the protection.

“I understand that because it’s a short-term note, the buffer has to be relatively small,” he said.

“Personally, I would have preferred a longer term with a deeper buffer.”

But the cap was satisfying as it matched his outlook for the ETF.

“In a normal market, that cap would be too low. But in light of where we are, it’s fair,” he said.

Barclays is the agent.

The notes settled on July 1.

The Cusip number is 06747Q5M5.

The fee is 0.75%.

© 2015 Prospect News.
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