Barclays' Super Track notes linked to MSCI Germany ETF could use higher cap, less leverage

By Emma Trincal

New York, Aug. 12 - Barclays Bank plc's 0% Super Track notes due Feb. 28, 2013 linked to the iShares MSCI Germany index fund have a poor risk/return profile due to the high volatility of the underlier and the mismatch between that volatility, the cap and the leverage, said Suzi Hampson, structured products analyst at Future Value Consultants.

If the fund finishes at or above the initial level, the payout at maturity will be par plus three times the gain in the fund, subject to a maximum return of at least 31% that will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will share fully in losses should the fund decline.

High risk

"The risk is very high," said Hampson, pointing to an 8.80 riskmap for this product.

The riskmap is a Future Value Consultants rating that measures the risk associated with a product on a scale from zero to 10.

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

The riskmap is the sum of two risk components: market risk and credit risk. In this case, the risk essentially derives from the market risk.

The riskmap is twice as high as other similar products, which show an average riskmap of 4.06. Those products with a similar structure include other leveraged products with or without protection.

In part, the notes are more risky because they lack any form of downside protection, said Hampson.

Volatile underlying

But the main risk factor is the underlying, an exchange-traded fund that tracks the performance of the German equity market, she added.

Hampson said that the fund has an implied volatility of 43%, compared with 25% for the S&P 500 index.

"I think what aggravates the risk here is the volatility of the underlying fund," she said.

"You compare these notes to leveraged buffers that tend to be linked to broad indexes, which tend to be much less volatile. If you had to make it less risky than say a note linked to the S&P 500 with a 10% buffer, you would certainly have to make the buffer bigger, for instance give it a 20% buffer," she said.

Return and cap

The risk/return profile of the notes, as measured by the return score, is "low," said Hampson, which means that the return compared to the risk is high.

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

The notes have a return score of 4.49, compared with 7.11 for similar structures and 5.95 for the average of all products.

"The return score is very low because given the risk of this product, you would expect more upside," said Hampson.

She noted that the 300% participation rate is high for a fund with this nature.

"You want to have a lot of leverage when you think the growth of the fund is going to be small," she said.

"But with the MSCI Germany fund, the volatility suggests that the price will move quite a lot thorough the term.

"The structure here, with that much leverage, increases the chances of hitting the cap.

"I would think that for this type of underlying, a note with a 200% participation rate for instance and a higher cap would give you a better risk return. It would be more appealing."

The mismatch between the implied volatility of the fund, the leverage factor and the cap could explain why the notes ranked lower on the return scale than comparable products.

Other products in this category may offer a cap and a leverage factor that may be better adjusted to the type of volatility of the underlying asset, she said.

Probabilities

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.

For this product, the chances for investors of generating an annual return in excess of 15% are 34%.

"This illustrates the high probability of hitting the cap," she said.

"And that's the worry investors may have with these notes: Once you hit the cap, you are likely to underperform the fund.

"So the question is: Do I want to invest in this product and take the credit risk and be locked in for one and a half year? Or do I want to go with the fund?

"If you look at this fund's volatility, it looks like it has the potential to grow much more than that."

And because there is no downside protection, investors have a great chance of losing money as well. According to the probability table, the odds of losses are 60% and within that, the probability of losing more than 15% of principal is 41%.

Timing of the offering

The product did not score well on the price score scale either.

Based on a scale of zero to 10, the 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 notes received a price score of 0.55.

"It's pretty bad," said Hampson. But she offered an explanation.

"The prospectus was filed Aug. 9. Since then, there has been a lot of increased volatility in Europe and in the U.S. The timing could possibly be wrong for this product.

"If the product was put together when volatility was lower, it would explain some aspects of the deal, such as not being compensated for the risk with a higher cap when the chances of hitting the cap are already high," she said.

Future Value Consultants delivers its opinion on the quality of a deal through its overall score by averaging the price score and the return score.

The product received an overall score of 2.52, compared with 7.68 for other comparable structures.

The notes (Cusip: 06738KRV5) are expected to price Aug. 23 and settle Aug. 26.

Barclays Capital Inc. is the agent.

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