Barclays’ capped leveraged notes linked to S&P 500 offer ‘reasonable’ cap but no protection

By Emma Trincal

New York, March 27 – Barclays Bank plc’s 0% capped leveraged notes linked to the S&P 500 index are designed for investors who do not have a strongly bullish outlook on the benchmark and want to maximize their return through leverage in an effort to outperform the market, said Tim Vile, structured products analyst at Future Value Consultants.

The notes are expected to mature 24 to 27 months after pricing, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus three times any index gain, subject to a maximum return of 19.8% to 22.8%. Investors will be fully exposed to any losses.

10% cap

Since the exact maturity date and maximum return will not be set before pricing, Vile picked hypothetical values to score the product. The cap of 21.3% was selected at the mid-point of the range while the shorter term of 24 months was chosen. Based on these assumptions, investors in the notes would be capped at 10.14% a year.

“The index would only have to go up by 3.5% a year to reach that cap. That’s not very ambitious,” Vile said.

“You get three-times up. This is very sharp leverage for someone who believes that the index is going to rise but only moderately.

“There is no downside protection, which means that the investor has to be bullish in the sense that there is no expectation of a market decline. At the same time, a very bullish investor would opt for less leverage and a much higher cap.

“The 10% cap is reasonable. But the fact that it can be achieved if the index is up only 3.5% shows that the underlying market view is really not very bullish. Yet, the notes are not designed for risk-averse investors.”

Notes offering more leverage but reduced upside appear to be more frequent, he said, adding that the view behind such trades may reflect current levels of the index.

“The S&P is obviously at very high levels right now. Someone buying this note doesn’t believe it’s going to rise by that much and wants to capture a decent return. If indeed the S&P doesn’t rise by more than 3.5% a year over the next two years, getting 10% will be a very decent return. It enables the investor to outperform the market,” he said.

Market riskmap

Future Value Consultants measures the market risk of a product on a scale of zero to 10 with 10 as the highest level of risk. Credit risk is rated in the same fashion.

The assessment of the risk associated with a product is simply calculated by adding the market riskmap and the credit riskmap, which are the two risk components.

The notes have a market riskmap of 3.72, compared with an average score of 3.62 for products of the same type.

“This note has no protection on the downside, so compared with other leveraged products that may have a barrier or a buffer, you would have expected a higher-than-average market riskmap. However, the underlying index is not very volatile. The one-year implied volatility for the S&P 500 is only 16.6%. Compared with stocks or other indexes, such as the Euro Stoxx for instance, it’s a bit less volatile, which balances out the market riskmap. Still, we see a reasonably high amount of market risk in this product,” he said.

The credit riskmap of the notes at 0.56 is the same as the product category’s average.

“It’s really the average. Barclays is not a bad credit, and it’s only two years,” he said.

Return score

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets and high- and low-volatility environments. Only the best market assumption is used to compute the score. In this case, the return score is calculated based on the bullish market scenario.

The return score is 7.37, compared with the product type’s average score of 7.69.

“The leverage is high, but the score comes in lower mostly because there is a cap. Other similar leveraged notes have higher caps or no cap at all,” he said.

“Also there is more risk due to the lack of any downside protection.

“More risk, capped upside. Both factors contribute to diminish the risk-adjusted return of the product, and it’s hard to say which one of the two has the greatest impact.”

Price, overall scores

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The 7.35 price score for the notes is higher than the average for the product type of 7.23.

“A bit higher, but really it’s pretty much average,” he said.

“It could have been less if we had picked the longer duration of 27 months to rate the notes.

“Also, the price score ends up a bit better than similar products in part because we’re using a strong, very liquid index.”

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

The notes have an overall score of 7.36 versus 7.46 for the average for the same product type.

“The return score brings down the overall score just a little bit, but it’s only marginal,” he said.

“This note would suit a mildly bullish investor looking for leverage to capture 10% per year and willing to take on risk. It’s all based on an investor’s view, someone who only foresees a low to medium market performance.

“Anyone with more bullish expectations should look for another note.”

Barclays is the agent.

The Cusip number is 06741USW5.

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