Barclays' worst-of notes tied to Nikkei, Topix sign of revived interest in unusual structure

By Emma Trincal

New York, Jan. 11 - Barclays Bank plc's expected pricing on Tuesday of a so-called "worst-of" note linked to two common benchmarks for the Japanese equity market may signal the re-emergence of a structure not seen very often recently, sources said.

Barclays plans to price 0% Super Track notes due Feb. 16, 2012 linked to the worst-performing of the Nikkei 225 index and the Topix index, according to a 424B2 filing with the Securities and Exchange Commission.

If the return of the worst-performing index is positive, the payout at maturity will be par plus double the index gain, capped at 18.5%. Otherwise, investors will share fully in the decline of the worst-performing index.

Back in fashion

Those deals are called "worst of" by sellsiders because the payout is only based on the performance of the index with the lower return.

"I haven't seen a lot of these recently," said Lisa Smith, a structurer at Bankers Financial Services. "But I've seen this one."

"I've seen these worst-of deals re-emerging lately, but very, very slowly. I wouldn't say that it's a trend just yet," a New York sellsider said.

Prior deal

Last month, though, JPMorgan Chase & Co. priced $3.27 million of callable yield notes due June 29, 2011 linked to the S&P 500 index and the United States Oil Fund, LP. The six-month notes carried a 7% annual coupon. The payout will be par unless the lower-performing component closes below its initial level by more than 25% during the life of the notes and the final level of either underlying component is less than its initial level. In such case, the payout will be the return of the lower-performing component.

The Barclays deal, in contrast, offers a different structure with leverage by a factor of two on the upside, an 18.5% cap and no downside protection.

"With a worst-of in general, the fact that returns are based on two underlying components increases your chances of losing money," said Smith.

Cap

She noted that the two underlying components in the JPMorgan deal - the oil exchange-traded fund and the S&P 500 index - are "not very correlated" compared to the two Japanese equity indexes in the Barclays notes. "You're better off when there is less correlation," she said.

But Smith said she liked the 18.5% cap on a one-year term.

"It's not a bad cap given what's out there. A 10% to 12% cap range is about what we've seen in the second half of 2010. Eighteen and a half percent is pretty good," she said.

Downside risk

Frederick Wright, partner and chief investment officer at Smith & Howard Wealth Management, said that he was not comfortable with the structure and the worst-of concept.

Regarding the structure, his main objection was the absence of downside protection.

"Both indexes are tied to the Japanese stock market, so they probably have a very high correlation," he said.

"Not only they're highly correlated, but there is no buffering in place.

"I'd like to see some sort of protection against the downside, especially if you have a cap."

Acknowledging that there is a trade-off in giving up protection for leveraged returns, he said that the notes represented a style of investing that just wasn't his.

"In general, I don't find it appealing to have leverage without any buffering," he said.

"It's an aggressive way to play structured notes.

"I personally prefer less leverage on the upside and more protection on the downside."

Gains off the table

Wright also said that he did not find the "worst-of" concept attractive.

"If you like both indexes, you might put your money in each and participate in the index that goes up," he said. "But with this particular note structure, if one goes up and the other goes down, you're not participating in the one that generates a positive return. It takes all that potential gain off the table.

"It might be more attractive if they gave you some participation in the index that went up or some downside protection. But you get none of these."

The notes (Cusip: 06741JBL2) were scheduled to price Tuesday and will settle on Jan. 18.

Barclays Capital Inc. is the agent.

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