Barclays’ $33.01 million enhanced step-up notes tied to S&P 500 boost returns in flat market

By Emma Trincal

New York, April 4 – Barclays Bank plc’s $33.01 million of 0% enhanced market-linked step-up notes due March 25, 2022 linked to the S&P 500 index give investors who believe that the strong bull market has run its course a chance to “lock in” modest returns over a five-year period even if the market is flat or even slightly down.

If the final index level is greater than the step-up value, 128.01% of the initial index level, the payout at maturity will be par plus the index return, according to a 424B2 filing with the Securities and Exchange Commission.

If the final index level is greater than or equal to the threshold level, 90% of the initial index level, but less than or equal to the step-up value, the payout will be par plus the step-up payment, 28.01%.

If the final index level is less than the threshold level, investors will lose 1% for every 1% that the index declines beyond 10%.

Buffer

“This deal comes with a buffer on the downside, which is always a good thing to have,” said Tom Balcom, founder of 1650 Wealth Management.

“If a client expects a low return going forward, this can be a way to generate small but consistent gains.”

The 28% step up value over five years is the equivalent of a 5% annual return on a compounded basis, he noted.

“The main advantage is your downside protection and also the fact that you can get that 5% a year even if the market is slightly down.”

Investors in the notes probably believe that the eight-year long bull market in U.S. equity may not be sustainable, he said.

“They’re not really bearish but they’re not very ambitious either. If your goal is to make such a small return, you have to expect a market that’s almost flat,” he said.

Total versus price

The step-up payment was the equivalent of a digital payout with no cap above this level, he said.

However, returns above the step-up would lag the index performance given that noteholders unlike shareholders are not entitled to receive dividends, he noted.

The S&P 500 index yields 1.90%. Therefore investors incur an opportunity cost of nearly 10% over the term of the notes as a result of not collecting dividends.

“Your optimal range is anywhere between the buffer and the step level,” he said.

“Below the buffer the notes and the fund give you the same thing because you have the 10% buffer and you have the 10% dividends so it’s a wash.”

It’s only when the price return of the index is more than 18% (which represents a total return of 28%) that noteholders would underperform the long-only position, he said.

Flat market

Adding or subtracting dividends however was not the only factor to take into consideration.

“You can outperform a lot in a weak market here,” he said. “That’s what the note is for. Somebody who thinks that the market had a strong run since 2009 may look at this and like it because even 5% a year is better than nothing and certainly better than losing money.

“This is really for people who don’t see much growth looking forward.”

Donald McCoy, financial adviser at Planners Financial Services, agreed.

“As long as you have low expectations for the overall market, this would be an appropriate investment for clients,” he said.

“You’re giving up dividends. But you have the buffer and the boost.

“The view is that the market is not going up a lot.

“If you’re right, if the benchmark goes nowhere or even drops, getting 5% a year may not be bad. I’m sure a lot of people would be happy with that.”

Rich market

McCoy explained that some investors are turning more cautious and that return expectations are becoming more subdued.

“Most people look at current valuations and get worried about it. This investment may offer a decent tradeoff,” he said.

He looked at recent five-year periods in which investing in the notes would have been beneficial.

Between for instance October 2007, when the S&P 500 reached its pre-financial crisis high and October 2012, the S&P 500 index dropped 8%. An investor in the notes gaining 28% would have significantly outperformed.

McCoy noted that while not designed for bulls, investors would still be “happy” in a bull market because the returns were not capped.

“All you’re losing are the dividends. That’s about it. Between the end of 2011 and the end of 2016, the market had an 80% rise. So you make only 70%. I don’t see many people complaining about it.”

However, the main benefits of the notes applied to moderately bullish investors.

“It would be a conservative approach,” he said.

“This is something for clients staring at the high valuations.

“I can see that as a way to encourage those people to get the equity exposure they’re so reluctant to make and to feel more comfortable about it.”

BofA Merrill Lynch was the agent.

The notes (Cusip: 06745T582) priced on March 30.

The fee was 2.5%.

© 2015 Prospect News.
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