Barclays' buffered return enhanced notes tied to four ETFs show compelling but complex payout

By Emma Trincal

New York, April 15 - Barclays Bank plc's 0% buffered return enhanced notes due April 30, 2018 linked to a basket of exchange-traded funds offer attractive features both on the upside and the downside, sources said. But the complexity of the payout calculation may put off a majority of investors, a financial adviser said.

The basket consists of the iShares MSCI EAFE ETF with a 46% weight, the SPDR S&P MidCap 400 ETF trust with a 23% weight, the iShares Russell 2000 ETF with a 19% weight and the iShares MSCI Emerging Markets ETF with a 12% weight, according to a 424B2 filing with the Securities and Exchange.

If at maturity the final basket return is greater than or equal to negative 25%, the payout will be par plus 1.85 to 2.05 times the average basket return. Otherwise, investors will receive par minus 1.33 times each point of decline in the final basket return beyond the buffer plus 1.85 to 2.05 times the average basket return.

The average basket return will be calculated using the funds' closing share prices on 16 quarterly observation dates and cannot be less than zero.

Too complicated

"It's way too complicated. No doubt about it," said Dean Zayed, chief executive at Brookstone Capital Management.

In the scenario in which the final basket return declines by more than 25%, the prospectus described the outcome in the following terms: "In such a scenario, the return on your notes will be negative if the average basket return multiplied by the upside leverage factor does not offset the product of the downside leverage factor multiplied by the sum of the final basket return and the buffer percentage. You may lose some or all of your principal at maturity, even if the average basket return is positive."

Zayed said that explaining this type of payout to a client would be very difficult.

"The way they calculate the final basket performance is too complicated for the average retail client. I don't see very much traction," he said.

Conceptually sound

"Don't get me wrong. I like the concept," he added.

"You have upside leverage and no cap. I have four ETFs which represent different asset classes in my portfolio with different weightings. The 25% buffer is good. Even the downside leverage is OK given that it's still a hard buffer and that you have four ETFs, which give you some diversification. I have no problem with that.

"Conceptually, they got it right. The structure looks and feels good. It's got some good pieces to it.

"I just think they have to have this calculation much more simple.

"It's probably part of the tradeoff. You have this highly complex payout, but it serves a purpose in your pricing. It gives you great upside, great leverage, no cap, a nice underlying, all that on a relatively short-term maturity.

"Maybe they're giving you too much. Maybe the drive to give you competitive terms led them to put together something very hard to explain.

"I'd rather have less leverage and a payout I can easily explain to a client.

"They've probably tried to do too much and pricing is getting in the way of it."

Attractive terms

Steven Foldes, president of Foldes Financial Management LLC, said that the benefits of the structure offset the inconvenient of having to explain a complex payout.

"This is a very compelling note. The 25% hard buffer: I haven't seen this in a long time. Up to two times leverage and no cap. I haven't seen it in a long time either. These are very positive things," he said.

Foldes also said that he likes the use of the averaging return to calculate the payout.

"The averaging smooths things out. Combined with a 25% buffer, it can dramatically decrease the decline. I like the idea of averaging on the downside as it can take you from negative to neutral. It can further mute volatility, which is a good thing," he said.

"The averaging also protects your upside. Imagine your basket is up by 40% but toward the end of the term, its value drops by 10%. Normally, you would have only 30%. But by averaging, you smooth out the ups and downs. So it's all good."

Even the geared buffer was not seen as a shortcoming.

"The negative impact of having some leverage beyond the buffer only comes into play after what would be a very dramatic decline. If your basket is down 35%, you're losing only 13.3% versus 10% with the equivalent non-geared buffer," he said.

Tenor, weightings

The notes have some less attractive features, he said.

"Four years is typically longer than we like to go out. That's one thing," he said.

"Also, I can't tell you that I love the weightings in the basket. You have a 58% international exposure and a 42% domestic exposure, and out of the domestic bucket, there is nothing in large caps. They're probably doing it for pricing in order to get you the two times upside and 25% buffer."

Besides those particular aspects of the product, Foldes said that he "loved" the upside leverage with a two-times factor and the fact that the note had no cap. On the downside, he said the hard buffer and the averaging provide a good defensive structure.

Complexity and quality

Complexity was also a drawback, but one that could be overcome, he said.

"It's true that the calculation of the final value of the basket is a bit complex. The ability to explain it to clients is pretty challenging. They made it a complicated note, but it goes with the territory. The terms are also very attractive," he said.

"I don't mind explaining something complex like this if it enables the product to be competitive. I can explain complex products. If I can understand it, I'll make sure that my clients can understand it.

"This is a very interesting note. There are some challenges, but the benefits offset the drawbacks. We don't see every day a two times leverage, uncapped note with a 25% buffer."

The difficulty Foldes said he faces in finding new products can sometimes lead him to roll money into other investment vehicles such as mutual funds.

"We tried to roll three notes recently and could only do one of them in real estate, with terms that were not as attractive as the maturing one. For the two others, in commodities and emerging markets, the caps were so low we had to go to mutual funds," he said.

"So even though this basket note is not perfect, even though it is fairly complex, hats off to Barclays to be able to price that type of product. We find it very compelling."

Barclays is the agent.

The notes will price on April 25 and settle on April 30.

The Cusip number is 06741UCE2.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.