Barclays' seven-year notes linked to S&P 500 offer simple alternative, but long tenor a risk

By Kenneth Lim

Boston, Sept. 8 - A series of seven-year principal-protected notes linked to the S&P 500 index offers potentially better returns than similar-maturity straight bonds, but investors must be willing to hold a relatively long-term investment, an investment adviser said.

Barclays Bank plc plans to price zero-coupon principal-protected notes due Sept. 29, 2017 linked to the S&P 500.

At maturity, investors will receive par plus any gain in the index, subject to a maximum return of 60% to 70%. The cap will be set at pricing.

Investors will receive at least par.

Straightforward structure

The adviser said the product offered an easy-to-understand structure that investors should be able to grasp quickly.

"I like the fact that it didn't take me one day of reading brochures to understand how this works," the adviser said.

Products with too many bells and whistles or overly-complex underlying indexes can be off-putting for many retail investors, especially those who are unfamiliar with structured products, the adviser said.

"It's very easy to get intimidated when the product has too many moving parts and fancy names for all of those parts," the adviser said. "The regular investor on the street just wants to know what he stands to lose, what he stands to profit and what the circumstances are for those."

Fixed-income alternative

Despite the linking of the note to an equity index, the product is probably better compared against a piece of debt issued by a high-grade company, the adviser said.

"The principal is protected, so I'd look at it more like holding a zero-coupon, floating-rate AA corporate bond," the adviser said.

High-grade seven-year corporate debt can yield about 3% to 4% right now, so the possibility of getting up to 60% to 70% over seven years in the case of the Barclays note could attract investors who are seeking higher yields, the adviser said.

"There's no way to get that kind of a return in today's low-interest-rate environment," the adviser said. "So this is definitely a very tempting kind of product to put before investors."

Investors should nevertheless be confident about the S&P 500 increasing over the next seven years.

"You've got to do your research into the asset that it's being linked to," the adviser said.

Long-term exposure

Buyers of the note also have to be prepared to hold on to the product for seven years, which is on the longer end of product maturities. That seven years is partly a "necessary evil" because volatility is high at the moment, the adviser said.

"They probably had to push out the maturity in order to offer principal protection and still have a decent participation rate and cap," the adviser said.

One of the risks for investors who hold the paper to maturity is not being able to reinvest when the bet goes south or a better option comes along, the adviser said.

"If the S&P 500 is down 10% after six years and I don't think it's going to do well after year seven, it's going to be hard for me to get out of this and put the money somewhere else," the adviser said. "You also have to remember that interest rates will probably rise at some point between now and 2017. I could be better off buying a shorter two-year bond, hold it to maturity and then reinvest it in something with a higher yield two years down the road and rinse and repeat this."

Investors also give up an income stream by investing in a zero-coupon instrument instead of a piece of straight debt that pays a regular coupon, the adviser added.

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