Investors in Barclays' digital notes linked to S&P 500 believe strong sell-off is unlikely

By Emma Trincal

New York, June 25 - Barclays Bank plc's 0% digital notes due Dec. 29, 2013 linked to the S&P 500 index are designed for investors who do not anticipate a serious market correction 18 months from now, sources said.

If the index finishes at or above the knock-in barrier level, the payout at maturity will be par plus a digital percentage of 10.5% to 11.5%. The knock-in barrier level will be 75% of the initial index level, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes below the knock-in barrier level, investors will be fully exposed to the index decline.

The exact digital percentage will be set at pricing.

No tail risk

"I like it. I don't see something huge in the next 18 months that would make the market fall 25%. Eighteen months is not very long, and Barclays has a good credit rating," said Carl Kunhardt, wealth adviser at Quest Capital Management.

Kunhardt said that the 75% trigger price offers a 25% barrier type of protection, which would be lost if the trigger were hit.

"While I'd much rather have a buffer, 25% is still large enough to give you some realistic protection," he said.

"I could realistically see the market down 10% or 15% because Greece if it goes will be dragging our economy down with it. But a 25% drop I don't think so. I could be wrong, but I just don't see it."

Equity bucket

However, the correction scenario cannot be ruled out, he said.

"When I buy a structured note I ask myself where does it fit into as an asset class and where am I going to substitute it for?" he said.

"I put structured notes in my alternative investment allocation. Usually I use it as a substitute for fixed-income, but in this case, it would be an equity replacement.

"No matter how much I don't think a 25% decline in the S&P 500 is going to happen, if it did happen, it would not be the type of loss that's easy to explain to a client as a fixed-income product."

Simple

Another attractive aspect of the product, according to Kunhardt, is its simplicity.

"It's easy to understand. There are not a lot of moving pieces. You have a final barrier, so you don't have to worry about what happens during the term of the notes. Either you finish above the 75% level or you don't," he said.

Risky bet

Another financial adviser said that the notes would not belong in his portfolio given his investors' risk tolerance. In addition, the risk/reward profile of the product does not make the cut, he said.

"It would be an issue for our clients to invest in something that leaves this extreme downside risk on the table. They would likely not be interested," said Jeff Daniher, co-owner of Ritter Daniher Financial Advisory.

"This is a product for someone who thinks that the market is not going to do much of anything, that it will be either flat or a little bit down.

"You really have to believe that the S&P 500 is not going to be down by more than 25% in a year and a half. I don't know that many people who have this strong conviction. It's a bet, and you're taking this bet for a pretty meager upside at 7.3% per year," he said, assuming a final digital percentage of 11%.

Meager upside

Holders of structured notes do not receive dividends. Compared to an equity investor long the index, investors in this note would lose the S&P 500 dividend yield, which is about 2%, Daniher noted.

"Rather than 7.3%, you're getting a little bit more than 5% without the dividend. I don't think it's worth the risk of losing your entire principal," he said.

"It doesn't strike me as 'Great! I can explain that to the client.' They're already shy or hesitant to purchase these products because they don't really understand them.

"You have to go over it with them: If the market is up, you get this but no more than this. If it's down but not down by more than that, you get this, otherwise you lose everything. ... It's a bit complicated.

"We would take a pass. I wouldn't make the effort to explain it."

Some features could have been improved, he said, citing the duration and the downside protection.

"An 18-month is a little bit too long. We may have considered it for a six-month," Daniher said.

"A buffer instead of the barrier would have made a difference.

"Our clients are extremely conservative. This product wouldn't address their biggest fear. They worry a lot about losing their principal."

Barclays Capital Inc. is the agent.

The notes will price Tuesday and settle Friday.

The Cusip number is 06741BY29.

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