Barclays' notes on S&P MidCap 400 offer alternative, more volatile equity play, says analyst

By Emma Trincal

New York, Aug. 27 - Barclays Bank plc's upcoming 0% buffered Super Track notes due March 14, 2012 linked to the S&P MidCap 400 index are designed for investors seeking to allocate to the U.S. equity market with possibly better terms than a standard note tied to the S&P 500, said Suzi Hampson, analyst at Future Value Consultants.

The payout at maturity will be par plus double any index gain, subject to a maximum return of 12% to 32% that will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 15% and will lose 1% for every 1% decline beyond 15%.

Correlation

The S&P MidCap 400 measures the performance of U.S. mid-sized companies, and there is an overlap between this benchmark and the S&P 500, as reflected by a great level of correlation between the two indexes, Hampson noted.

"The one-year correlation calculated using weekly values is 96.79%," she said. "It's high!"

The high correlation lets investors who have used notes tied to the S&P 500 take advantage of a different underlying to achieve a similar performance, she said.

Implied volatility

Yet, investors looking at the note may find it, from a structural standpoint, more attractive as it can deliver better terms than a typical note linked to the S&P 500, she said.

That's because the one-year implied volatility for the S&P MidCap 400 is 31.1%, compared with 27.4% for the S&P 500 right now, she noted.

With more volatility, performance potential is enhanced, she added.

Hampson looked at a similar note, a Royal Bank of Canada buffered bullish enhanced return product linked to the S&P 500 with exactly the same tenor, leverage factor and buffer amount. The main difference, besides the issuer and the underlying, was the cap range of 13% to 17%.

"It looks like with the S&P MidCap 400-linked product, you get better terms as the cap is higher," she said.

"This does suggest that, as the underlying has a higher volatility, the structure will have a higher maximum return, although we won't know until the product has reached its pricing date and the final terms have been set."

And this level of uncertainty can pose a problem in the rating of a deal prior to pricing, she warned.

Cap wildcard

The unknown factor, she said, is the cap, with a range comprised between 12% and 32% and to be set at pricing. "It's a huge range," said Hampson, and "it's likely to have a considerable impact on the scores."

Hampson said that issuers' tendency to present their deals with preliminary ranges that can vary widely is characteristic of the U.S. market.

"In the U.K., we don't have that. You have a fixed cap, fixed terms and six weeks to invest," she said.

For that reason, Hampson said it's hard to conclude that difference in volatility is the main factor behind the difference in terms between the S&P 500 product and the S&P MidCap 400 note.

"Until the product prices, you don't really know what the cap is going to be," she said. "This why we systematically revise our ratings after pricing."

Hampson said that cap ranges that are as wide as 20 percentage points as it is the case here makes the job of analysts more challenging.

"It makes it difficult to compare products. We don't really give recommendations. But with this wide gap, the value score, the return score and the overall rating are likely to be affected," she said.

Since Future Value Consultants has to "pick an hypothetical cap" in order to run its model, a rule followed by the analysts at the firm is to select a maximum return at 75% of the range. With this product, the cap is estimated at 27%.

"It's our methodology. We have to pick a level. At 75% of the gap, we somehow give issuers the benefit of the doubt. But obviously, if they price it at the lower end - 12% here - instead of our hypothetical 27%, you'll see a big difference," she said.

Return score

The return rating, Future Value Consultants' indicator, on a scale of zero to 10, of the risk-adjusted return of the notes, is 7.30 for this product.

"It's a high return score. We see a lot of them below that. Our average is about 4 right now," she said.

Deriving from the same parameters and the same Monte Carlo simulation, the probability return table shows an 80% chance to yield a positive performance versus 20% to incur a loss.

On the gains side, the bulk of the probabilities - nearly 50% - is concentrated in a bucket of positive returns comprised between 15% and capped at the maximum return.

"But again, it has to do with the wide cap range and the fact that maximum returns are not fixed. If the cap was 12%, the return score would be a lot lower," she noted.

The value rating at 9.88 is also high, she said.

Based on a scale of zero to 10, the value rating represents the real value to the investor after deducting the costs the issuer.

Low risk

One factor that is not impacted by the uncertainty around the final cap level is the measure of risk, Hampson said.

This deal has a low riskmap of 3.06, a score that is lower than the average of the firm's recently rated deals, she said.

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

"This time, there is no variable level. Riskmap measures the probability of losing capital. We know the underlying. We know the buffer. The risk has nothing to do with the cap, and riskmap is not affected by the range," she said.

The double leverage combined with the capped return should attract investors only moderately bullish in the mid-cap equity market, she said.

"You don't need the index to grow that much, so you would have to be less bullish than someone investing directly in the tracker or the equivalent [exchange-traded fund]," she said.

"These notes are for someone who wants exposure to the U.S. equity market but possibly not to the S&P 500," she noted.

The notes (Cusip: 06740PMY9) will price Sept. 9 and settle Sept. 14.

Barclays Capital Inc. is the agent.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.