Barclays' contingent return notes linked to Russell 2000 offer good value for cautious bulls

By Emma Trincal

New York, June 3 - Barclays Bank plc's upcoming 0% contingent return optimization securities due June 28, 2013 linked to the Russell 2000 index are designed for cautiously bullish investors, said Suzi Hampson, structured products analyst at Future Value Consultants.

"Investors in this product want to bet on the appreciation of the index but with some protection, and they're willing to accept the trade-off of a limited upside," she said.

The notes offer par of $10 plus the index return subject to a minimum return of 10% even if the underlying index is negative at maturity, as long as the final index level is at least 75% of the initial level, according to an FWP filing with the Securities and Exchange Commission.

If the final index level is less than 75% of the initial level, investors will be fully exposed to the index decline.

On the upside, gains will be capped at 28% to 33%.

"You can get the minimum return of 10%, even if the index is negative at maturity, as long as it stays above the 75% barrier," said Hampson.

"A slightly bullish and slightly bearish investor in that case could outperform the Russell 2000.

"Obviously, the best-case scenario is if your index rises up to the cap. That's why these notes are primarily for bullish investors, but you don't want to be too bullish because of the cap."

She said that the note would also work for investors who anticipated moves of the index within a range, either up (below the cap) or down (above the barrier), but weren't sure about the direction of the index.

Generous barrier

The downside protection included in this structure is offered through a 75% barrier, not a 25% buffer, noted Hampson, which represents an important difference.

"A barrier creates more risk than a buffer because once you breach it, you lose from the 100% initial price strike; with a buffer, you get to keep the buffer amount," she said.

However, the notes offer the particularity of showing a fairly low level of risk, and Hampson explained why.

"First, most buffers are 10%, 15% at the most. Here you have a 25% protection level, which is quite generous. Most investors would prefer a 25% barrier to a 10% buffer," she said.

"Second, you have a final-day barrier. Unlike many buffered notes, in particular reverse convertibles, where the index performance is monitored at any time during the life of the notes, here it's point to point. That greatly reduces the likelihood of hitting the trigger.

"You may lose a large amount if you breach the barrier, but the probability of this happening is much lower than if you had a buffer."

A third factor helps limit downside risk: the implied volatility of the underlying index.

The one-year implied volatility of the Russell 2000 index is about 26% versus about 19% for the S&P 500 benchmark, said Hampson.

"It's more volatile than the S&P 500, which is probably why they chose this index, but it's a lot less than a stock or an emerging market fund," she said.

Low riskmap

Riskmap - a Future Value Consultants rating that measures the risk associated with a product on a scale from zero to 10, is 3.18 for this product. The score is lower than the average riskmap for all recently rated products (5.16) and even less than products with a similar structure (4.71).

"It's a combination of a generous protection, a final-day barrier and an underlying index that is not excessively volatile," said Hampson.

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

With these notes, market risk is lower than with other products, but the credit risk is higher.

"This is a two-year product. When you compare it to a three-month reverse convertible, your credit risk is going to be higher," explained Hampson.

High return

Another positive of the product is its high return score, she said.

The return score, which is 7.82 here, is Future Value Consultants' indicator on a scale of zero to 10 of the risk-adjusted return of the notes.

This in part is the result of the low riskmap, she said.

Another factor is the high probability of getting at least the 10% minimum contingent return, she noted, pointing to the 0% to 5% return bucket in the probability tables of return outcomes.

Future Value Consultants calculates those probabilities using a Monte Carlo simulation. The performance is modeled based on a series of parameters that include volatility, dividends and interest rates.

Investors have a 40% probability of getting their minimum return because they obtain it over a large range of performance points, she said.

"If your index finishes between 75% and 110%, you'll get the contingent minimum. That's a 35-point range. It increases the probability of hitting that return bucket," she said.

Finally, investors enjoy a "pretty high cap," said Hampson.

While the cap is the trade-off investors have to accept in order to get the barrier and the contingent return, the issuer has introduced a 14% to 16.5% annualized maximum return, which "isn't bad," she noted.

Overall, the probability of generating a gain for the investor is 84% versus a 16% chance of incurring a loss.

"Overall, the risk/return is favorable to the investor, which is why the notes score high on the return. The potential return over the risk you take is good."

Good value

The price score, Future Value Consultants' estimate on a zero to 10 scale of the total costs taken out of the product from direct fees and profit margin on the underlying derivative, is 9.66.

"This is top bracket. We calculated the assets purchased as a percentage of the initial price of 100% and there was not a lot of fees taken out; the cost is being kept down," she said.

The overall score, Future Value Consultants' opinion on the quality of a deal based on the average of the price score and the return score, was as a result high as well. On a scale of zero to 10, the notes received a 8.74 score, which is much more than the 5.99 average for all products or even the 7.39 score for products with a similar structure.

"This product offers high return potential given the risk, and its pricing offers good value for investors," said Hampson.

The securities (Cusip: 06741K338) will price June 27 and settle June 30.

UBS Financial Services Inc. and Barclays Capital Inc. are the agents.

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