Barclays' leveraged notes linked to iShares EM fit modest growth view on emerging markets

By Emma Trincal

New York, Oct. 14 - Barclays Bank plc's upcoming 14-month 0% Super Track notes linked to the iShares Emerging Markets index fund are for bullish investors willing to take full downside risk but who expect only contained growth in emerging markets over the short term, said Future Value Consultants structured products analyst Suzi Hampson.

The payout at maturity will be par plus triple any fund gain, up to a maximum return of 27% to 36%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will be exposed to any losses.

The exact cap will be set at pricing.

Mild bulls

"If you're very bullish, obviously you would go for the fund directly or you would pick a similar product but with a higher cap and less gearing," she said.

"Investors in this note have no downside protection. So their risk profile is the same as an investor in the equity fund."

Assuming a cap set at about 34% for the 14-month period, investors would only need the underlying fund to grow by 9.7% a year to hit the 29% maximum annualized return, she said.

The product offers an accelerated return based on a relatively modest growth outlook, she said, at least modest for emerging markets.

The 37% implied volatility of the underlying fund is "high," she said.

"This is for an investor who is quite happy taking the full risk exposure," she said.

"They are bullish but not overly bullish. If you want 15% per year, then you have the wrong product.

"This is really for someone who has a target return in mind and wants to maximize the chances of getting there because you need less index growth to get there. That's the whole idea of leverage."

Risk

But the trade-off is more risk on the downside.

At 6.77, the riskmap is much greater than similar leveraged structures, which show a 4.44 riskmap, she said.

A Future Value Consultants' rating, the riskmap measures the risk associated with a product on a scale from zero to 10. The higher the riskmap, the higher the risk of the product.

The rating compares the average product underperformance (relative to cash) with the average underperformance of five sample assets of different volatility levels. The risk rating equates the risk of the products against the five hypothetical assets.

"You have no barrier whatsoever, while many leveraged products offer some kind of protection, either a buffer or a barrier," she said.

"In addition, comparable leveraged notes are often tied to indexes that are much less volatile than this fund."

The riskmap is the sum of two risk components: market risk and credit risk.

The market risk for the notes is much greater than similar products and also higher than the average of all products.

"For both categories, the lack of any downside protection explains the high market risk," she said.

The credit riskmap is mild compared to the average for similar products, which is due to the issuer's creditworthiness.

"Barclays' credit risk is not bad compared to others," said Hampson. She said that at 198 basis points, Barclays' credit default swap spread is much tighter than Bank of America Corp. (370 bps) and Morgan Stanley (394 bps).

Risk/return profile

This product does not maximize return opportunities based on the amount of risk taken compared to its peers.

At 6.49, the notes' return score is less than the average score of products of the same type, 7.13.

The return score is Future Value Consultants' opinion of the risk-adjusted return under reasonable and consistent forward-looking assumptions for underlying asset evolution on a scale of zero to 10.

"In this case, the return score is lower because for one you have no barrier and also because the potential return you're getting on this compared to the risk you're taking is probably lower than with other enhanced products," she said.

"If there is a high chance to hit the cap, it will also affect the score because you should expect a higher cap."

Growth assumptions

The return score derives from the probability of return outcomes calculated by Future Value Consultants using a Monte Carlo simulation and displayed in a chart across different return buckets.

The performance is modeled based on a series of parameters, which include volatility, dividends and interest rates among others.

Under a neutral growth scenario, there is a 43% probability of generating a gain of more than 15% per year but a 30.2% chance of losing more than 15% of principal, according to the table.

In the calculation of the return score, Future Value Consultants use five key assumptions: neutral assumption, high- and low-growth environments and high- and low-volatility environments. The firm calculates a risk-adjusted average return for each assumption. The return score is the best of these five returns.

The "best scenario" will vary depending on the type of structure, she said.

For instance, with a reverse convertible product, the best scenario would be "low volatility." Inversely, the best assumption for a principal-protected product would be "high volatility." In the case of enhanced return notes, high growth would be the optimal picture, she said.

If the assumption is changed and defaulted to the high-growth scenario, the chances of generating the highest gain become 52.2%, compared with 43% in the neutral assumption. The odds of incurring a loss in excess of 15% are lowered to 22.4% from 30.2%.

Price and overall

The product is slightly less attractively priced than similar notes as evidenced by its 6.97 price score versus 7.16 for other leveraged products.

Based on a scale of zero to 10, the price score represents the real value to the investor after deducting the costs the issuer charges in fees and commissions on an annualized basis and profit margins on the underlying derivative.

"The price score is not confirmed yet as the issuer has yet to set the final cap," said Hampson.

"But the difference for now between the two categories is not striking. This is about average."

Future Value Consultants offers its opinion on the quality of a deal with its overall score, the average of the price score and the return score.

The notes received a 6.73 overall score, which is better than the average of all other products at 6.0 but less than the 7.14 average score for products of the same type.

"The overall has been pulled down by the return score. Still, it's scoring well. If they put the cap at 36%, it would be pushing above that average level," she said.

Barclays Capital Inc. is the agent.

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