Barclays’ notes linked to Bloomberg Commodity 3 Month Forward offer unique exposure, liquidity

By Emma Trincal

New York, May 26 – Barclays Bank plc’s 0% daily liquidity notes due June 2, 2017 linked to the Bloomberg Commodity Index 3 Month Forward Total Return offer exposure to a different version of the well-known commodity benchmark with the benefit of a daily put option, sources said.

The payout at maturity will be the indicative note price three days prior to the maturity date, according to an FWP filing with the Securities and Exchange Commission.

The indicative price reflects the performance of the index on a one-to-one basis minus the fee.

The investor fee is 0.6% per annum. It is calculated on a daily basis.

The notes are putable at any time. The payout will be the indicative note price.

One of the main advantages of the notes, sources said, is the issuer’s offer to repurchase the notes daily.

“This seems to be a new type of structure that focuses on liquidity without the need to be exchange traded,” said Dean Zayed, chief executive officer with Brookstone Capital Management.

Jonathan Tiemann, founder of Tiemann Investment Advisors, LLC agreed.

“If you’re able to put it back to the issuer when you knock on their door, it might make sense. Their ability to make good on this promise is a credit issue. You have to assess that risk too,” he said.

3 Month Forward

Access to the underlying index may also be a rationale behind the investment.

“I don’t think there are any ETF or ETN tracking the [Bloomberg Commodity Index 3 Month] Forward in the U.S. I know there are ETFs that do that in Europe,” an index specialist said.

The Bloomberg Commodity Index 3 Month Forward Total Return follows the methodology of the Bloomberg Commodity index (formerly known as the Dow Jones – UBS Commodity index) except that the delivery month for each futures contract is three months later than the delivery month for the corresponding futures contract composing the standard Bloomberg Commodity index, according to the prospectus.

Sources said that offering direct exposure to the “forward” version of the Bloomberg commodity benchmark, not the standard version, may be an advantage.

‘Generation one’

A person familiar with the index methodology explained the differences between the widely used Bloomberg commodity benchmark and the note’s underlying index.

“The 3 Month Forward allows you to look ahead further in the curve. You know in advance what’s in the index months ahead of time. There is no rebalancing or dynamic roll formula though. It’s merely the standard contract calendar plus three months,” that person said.

The term “curve” refers to the forward yield curve spotting the months of delivery of the underlying futures contracts that constitute the index. As those get replaced at expiration, which means the expiring contract is sold and replaced via the purchase of another one at a later date, a curve with a positive slope will reduce gains. That’s because contracts are sold at a cheaper price than they are bought. This phenomenon, called “contango” or negative roll yield, can negatively impact the returns, according to the prospectus. The opposite effect (the shorter-dated contracts are more expensive than further ones), which is called backwardation, brings to investors positive returns in the form of a positive roll yield.

“It’s not designed to pick the best yield on the commodities curve,” this person continued.

“There are other indexes that do that, rebalancing the weightings each month to minimize contango and maximize backwardation. This one doesn’t offer a dynamic roll. It’s a fixed schedule. It just looks three months ahead.”

Michael McGlone, director of research of ETF Securities, put it a different way.

“By way of moving further out of the curve, they hope to reduce potential contango,” he said.

“It’s designed to reduce contango, but it’s a simplistic way of doing it.

“It’s the ‘generation one’ of contango busters in the commodity space.

“That said, it can make a difference.”

The Bloomberg Commodity Index TR posted a 25.22% loss for the past 12 months versus a 22.73% decline for the 3 Month Forward version, according to Bloomberg’s website.

Dynamically rolling methodologies are designed to reduce contango by using flexible monthly futures contracts that roll on the best part of the curve.

One example is the S&P GSCI Dynamic Roll index, which was one of the first indexes of this kind.

ETN and basis risk

Investors who just want exposure to the traditional Bloomberg Commodity Index TR can always get access to it via an ETN, the iPath Bloomberg Commodity Index Total Return, sources noted.

But the structured note may offer advantages over the ETN, said Tiemann.

“With an ETN you have to find a secondary market buyer,” he said.

“Usually, it’s not difficult. But as you can imagine it can occasionally be an issue.

“ETNs may involve more basis risk, or deviation between the price of the derivative and the price of the underlying.

“If you’re buying or selling an ETN in the market, you might find you have to buy at a premium and sell at a discount of the asset value, whereas if the issuer agrees to let you put the notes back to them, this type of risk is out.”

The issue with the notes is the credit risk, he said. But investors are exposed to credit risk as well with an ETN.

“I’m not a big fan of ETNs. I like ETFs that are not leveraged and that track well-understood, straightforward indexes.”

Access

For Zayed, the notes offer exposure not just to commodities but to the method the underlying index is using with its three-month forward version.

“You would buy this note if you thought the cost was lower than the ETN, the underlying was more attractive or you simply preferred this method of liquidity over the exchange-traded liquidity.”

Because an ETN linked to the forward version of the Bloomberg Commodity Index TR does not exist, the notes offer the benefit of access.

“It seems attractive,” he said, commenting on this particular point.

Investors in the notes would have to be bullish on commodities, an asset class that has suffered negative returns since 2011, sources said.

“Personally, I’m not a big fan of commodities because when you invest in commodities, you’re not putting capital to work in the productive economy. You’re just hoarding stuff and hoping prices will go up in the future,” Tiemann said.

“But if this is where you want to put your money, it seems like a pretty reasonable note.”

Barclays is the underwriter. J.P. Morgan Securities LLC and JPMorgan Chase Bank, NA are agents.

The notes are expected to price Thursday and settle June 2.

The Cusip number is 06741UVL5.

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