Barclays' Super Track notes linked to Financial Select Sector SPDR fund are bet on recovery

By Emma Trincal

New York, May 21 - Barclays Bank plc's upcoming 0% Super Track notes due June 30, 2011 linked to the Financial Select Sector SPDR fund are designed for bullish investors betting on the recovery of the financial sector and determined to get the best possible outcome with leverage, said Suzi Hampson, structured products analyst at Future Value Consultants.

The payout at maturity will be par plus double any fund gain, subject to a maximum return of 16.25% to 20.25% that will be set at pricing. Investors will be exposed to any fund decline, according to an FWP filing with the Securities and Exchange Commission.

Volatile financials

The Financial Select Sector SPDR, an exchange-traded fund, has been very volatile over the past few weeks, said Hampson, with an implied volatility of approximately 45%.

"Compared to the 30% volatility for the S&P 500, it's very volatile," she said.

Fund shares rose by 18.5% from January up until mid-April before dropping by 13.5% since then.

High risk

"This is a high-risk product," said Hampson. "It's the same downside risk as a direct investment in the equity. You don't have any buffer. So the reason you would take the credit risk and invest in the notes is for the two-for-one upside."

Decent cap

If the cap was set at 18%, a 9% growth of the fund would give investors their maximum return of 18%, she said. "And 18% for a year is a lot.

"However, if your view is that the sector will grow by more than 9%, obviously, these notes wouldn't be for you."

Hampson said that the decisive factor for investors will not be the cap, as she sees the cap range as "fairly decent."

Instead, investors are more likely to make their decision based on their market view for the underlying financial sector and their growth prediction for the next 12 months.

Recovery product

These products are sometimes referred to as "recovery products," said Hampson. Investors who buy that type of strategy expect the sector to recover over the next year. "They hope to secure two times that growth," she said.

Investors should have a high level of risk tolerance before investing in the notes, she warned. "You have to be comfortable with risk, she said.

"This is similar to a stock investment since you have no downside protection. In fact, you can really look at this as an alternative to a direct investment in the equity fund," she said.

The product carries a "high riskmap" of 7.63, according to Hampson.

Riskmap is Future Value Consultants' rating that measures the risk associated with a product on a scale from zero to 10.

"You have no barrier, and the volatility is reasonably high. That gives you greater chances of losing more, and it's therefore risky," said Hampson.

High gains potential

But potential returns make the product attractive as investors have a chance to outperform the underlying.

Hampson analyzed her firm's return probability tables, which simulate performance based on a Monte Carlo simulation that includes several parameters such as volatility, dividends and interest rates. The result was a set of good probabilities to generate gains from this investment, she said.

Investors have a 49% probability of generating a return in excess of 15% up to the cap. When adding the various probabilities of gains, investors may expect a 56% chance to earn a return anywhere from over zero to the cap.

On the negative side, investors face a 44% probability of losing some of their principal. And the odds of losing more than 5% of their initial investment are 40%, according to Future Value Consultants' report.

"This is a high risk/high return product," said Hampson.

These results are reflected in the return rating, Future Value Consultants' indicator of the risk-adjusted return of a given product on a scale of zero to 10.

The notes offer a 4.34 return rating. "It's not bad in comparison to other products," said Hampson, who weighed it against all products her firm recently rated, which include a variety of different structures.

Volatility and value

Another rating Future Value Consultants includes in its research is the simplicity score. It measures on a scale from zero to 10 how straightforward a structure is and how easy it is for investors to understand it.

The simplicity rating for these notes is high at 8.50.

Future Value Consultants rates the quality of a deal on a scale of zero to 10 through its overall rating.

This product carries a low overall rating of 3.65, according to the firm's report.

The overall score takes into account costs, structure and risk-return profile. It's an average of the three scores weighted 40% to the value score, 40% to the return score and 20% to the simplicity score.

Because the notes have a relatively good return rating and a high simplicity rating, the low overall score results from the third weighted score, said Hampson.

"The value rating of 0.53 is very low. It affects the overall rating," she said.

Value rating on a scale of zero to 10 is Future Value Consultants' measure of how much money the issuer spent directly on the assets versus other transaction costs such as direct fees and profit margin on the underlying derivative.

The value score for this product was calculated earlier this month when the product was first announced. It will be recalculated at pricing, Hampson said. A month ago, the implied volatility for the fund was at 30. It has now moved up above 40, Hampson said.

"These products are very volatile to movements in the markets, such as interest rates, volatility or dividends. Since volatility has been on the rise quite a lot from the day we scored the product, I expect that the value rating will go down even further. My guess is that the issuer will have to raise the cap level closer to its higher end, perhaps to the maximum 20.25% level," she said.

The notes are expected to price Tuesday and settle Friday.

Barclays Capital Inc. is the agent.

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