Barclays' trigger PLUS linked to Vanguard FTSE EM fund seen as attractive for contrarian bulls

By Emma Trincal

New York, July 25 - Barclays Bank plc's 0% trigger Performance Leveraged Upside Securities due July 31, 2015 linked to the Vanguard FTSE Emerging Markets exchange-traded fund offer attractive upside potential for investors who see the emerging market asset class turning after years of underperformance compared to the S&P 500 index, sources said.

The underlying fund, one of the most popular ETFs along with the iShares MSCI Emerging Markets index fund, replicates the FTSE Emerging Markets index. Unlike the MSCI Emerging Markets index, which used to be the reference index for the Vanguard fund up until January, the FTSE Emerging Markets index excludes South Korea, considered to be a developed country. Vanguard switched to the FTSE Emerging Markets index after a six-month transition that began in January, according to the prospectus.

The payout at maturity will be par of $10 plus 1.5 times any gain in the fund, up to a maximum return of 46% to 50%. Investors will receive par if the shares fall by up to 15%. If the shares fall below the 85% trigger level, investors will be fully exposed to the decline from the fund's initial share price.

More protection wanted

Steve Doucette, financial adviser at Proctor Financial, said that he is bullish on emerging markets, which he sees as potentially bouncing back. The only wildcard is the timing, he said, which makes the downside protection component of the structure very important in any decision.

"I don't know about this particular index. I might look at it. If you take out South Korea, you're also removing companies like Samsung or Hyundai, which are pretty good at creating products and meeting consumers' demands. So I'm not sure of the benefits of that," he said.

"But I like the asset class. It makes sense. Emerging markets have been down a lot, and they are significantly lagging the S&P 500.

"Unless everything turns down, eventually it will catch up with the S&P. The only question is the two-year timeframe. ... We may go through a whole new market cycle, and you can't really tell if the 85% barrier will be enough or not."

While the upside is attractive with the combination of a 150% participation rate and an annual cap of about 23% to 25%, Doucette said that he would want more downside protection even if it meant reduced gains.

"I might look at a buffer instead of this barrier. You probably would have to give up some of the upside; most likely the cap would have to come down. I would have to take a look at that or see if getting slightly less leverage may be another way to accomplish it," he said.

The S&P 500 index has gained 18% year to date while the Vanguard FTSE fund has lost 11%, he noted.

"That's a 29 points spread. I would think that the gap would have to narrow. Very often, when you have that type of underperformance, you can expect some sort of mean reversion. Even if you get 15% or 16% a year in return, nobody would complain about that," he said.

Good entry point

For Matt Medeiros, president and chief executive of the Institute for Wealth Management, more protection is not necessarily needed given how much the Vanguard FTSE Emerging Markets ETF has lagged other asset classes.

"I think we have a very good entry point at current levels. I'm quite comfortable with the 85% barrier. It seems very attractive relative to where the security is trading today," Medeiros said.

"The emerging markets haven't done much over the last couple of years.

"We've had fluctuations up and down, but we're now at levels that are lower than what they were back in 2011."

Medeiros looked at a two-and-a-half-month sharp price downturn that occurred in the summer of 2011 when the ETF fell 25% to $35.83 on Sept. 30 from $47.73 on July 15. The ETF closed at $40.19 on Thursday.

"I think there are opportunities in emerging markets given the price levels we have today," he said.

"What's nice about this note is that it has a 15% downside protection on an asset class that is already below 15% where it was in 2011."

While today's share price is 12% higher than its two-year low on Sept. 30, 2011, it is still 16% below its July 15, 2011 peak, he noted.

Barrier, cap

"The barrier is attractive for this kind of asset class. The fund today is still more than 15% lower than what it was in 2011. If you consider par level to be mid-2011, the buffer sits at a relatively low point versus par. This is a fund that dropped 25% during the summer of 2011. It's barely off its lows now," he said.

"While the fund has rebounded from that period, it's still way below its highs of two years ago.

"I don't see the index falling another 25% like it did back then. It's already 15% below what it was in July 15, 2011."

From a fundamental standpoint, caution is required when investing in emerging markets, he said. But the structure of the notes should appeal to bullish investors with realistic expectations.

"You have to keep an eye on commodity prices. Commodities are always a concern," he said.

"You also have to be concerned with political uncertainty. If you look at emerging markets, you have to take those two factors into consideration.

"But I believe that these countries will continue to progress. Perhaps they will progress slower than what we may have anticipated based on history. That's how the leverage feature in the notes should be very helpful. I'm also very comfortable with the cap. The cap is very sufficient for this asset class over this time period."

The notes (Cusip: 06742D531) are expected to price on Friday.

Barclays is the agent with Morgan Stanley Smith Barney LLC as dealer.

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