Barclays’ SuperTrack notes tied to iShares Nasdaq Biotech ETF target mildly bullish investors

By Emma Trincal

New York, May 26 – Barclays Bank plc’s 0% SuperTrack notes due Aug. 3, 2018 linked to the iShares Nasdaq Biotechnology exchange-traded fund offer a structured alternative to a direct equity investment, said Suzi Hampson, structured products analyst at Future Value Consultants.

“Obviously the choice of this underlying suggests that this is for people who want exposure to this particular sector. It’s more of an access product. At the same time, you’re getting a different payoff, so it’s not like buying the ETF directly,” she said.

“This payoff is best for investors who are only slightly bullish.”

If the ETF return is positive, the payout at maturity will be par plus three times the ETF return, subject to a maximum return that is expected to be 15% to 17% and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission. For her report, Hampson assumed a 16% cap at mid-point of the range.

If the ETF return is negative, investors will have one-to-one exposure to the decline.

“This allows you to get three times leverage on the upside, which you wouldn’t have with the ETF, but for that you have to be capped. If you compare your downside with the ETF, you are not worse off,” she added.

Capital performance

Future Value Consultants produces stress test reports for structured notes. Each report comprises 29 different sections providing probabilities of outcomes, which vary by product types as well as average payouts. The results may be simulations or backtested. Some tables also provide an analysis based on five different market scenarios – neutral, bullish, bearish, less volatile and more volatile.

The capital performance tests table showed that the odds of making money are relatively high with this product despite the absence of any barrier or buffer.

This table is a simulation showing the probability of three mutually exclusive outcomes: “return more than capital,” “return exactly capital” and “return less than capital.”

The results are displayed for each of the five market scenarios.

Gains by markets

The probability of getting exactly par back is zero. “It’s just not happening,” she said.

Getting a positive return happens 56.65% of the time in the default or “neutral” scenario, which assumes a 1.4% annual growth rate.

The neutral scenario is calculated using the risk-free rate and the issuer credit spread.

In the bull market simulation, the positive outcome occurs 69.73% of the time.

More surprising is the relatively high probability of gains (42.65%) with the bear assumption.

“The bear scenario doesn’t necessarily mean the market is going to go down. For the bull, we add some growth to the neutral growth rate, and for the bear, we take away some of it. The growth assumption will go down but not all the time,” she said to explain the counterintuitive result.

A comparison between the less volatile and more volatile scenarios showed that investors are more likely to earn a positive return in the less-volatile environment (58.73% of the time) than in the more-volatile one, which showed a 55.13% chance of occurring. The difference, however, is not significant, she noted.

“It makes sense. If you increase volatility, your potential return doesn’t go above the cap while the chances and the magnitude of the losses increase,” she explained.

Payoff around cap

The bottom part of the capital performance table illustrates the average payoff per outcome distributed by market assumptions. Those payoffs do not take into account credit risk.

“An interesting thing to note here is that when you have positive returns, regardless of the market scenario, all average payoffs tend to be near the cap,” she said.

“This simply means that you have a greater chance to hit the cap. Obviously the amount of leverage you have is the main factor here.”

The 16% hypothetical cap offered by the issuer represents the equivalent of a 12.60% annual return on a compounded basis. It would take the ETF only a 4.25% annualized rate of return to enable investors to reach the cap.

“Three times the upside is quite a lot, and you don’t need a lot of growth to maximize your return,” she said.

The average payoff when investors get a positive return is slightly over 14% when averaging the value of each of the five average payoffs per market assumptions.

Capital losses

When it comes to the amount of losses, volatility and falling stock prices are obviously the worst scenarios.

The more-volatile market leads to an 18.2% average loss; the bear scenario, a 17% average loss.

The fact that losses are greater with the more volatile environment than with the bearish case illustrates the tight relationship between risk and volatility when there is no downside protection, she said.

Rosy past

A look at the backtested version of the capital performance simulation showed an entirely different and much brighter picture.

“That should not come as a surprise,” she said.

For instance the probability of getting a positive return in the neutral scenario jumps to 79.26% for the last five years and to 74.55% for the past 10. In comparison, the simulation showed smaller chances of making money with a probability of 56.65% for the neutral scenario and a 69.73% chance in the bull market.

“These give you more positive outcomes than any of the forward-looking simulation,” she said.

“In the past five and 10 years your probabilities are much better than even what we project in our bullish simulation.”

One has to go back to the past 15 years to find a backtesting probability of 69.61% that nears the bull market simulated value.

“Backtesting always looks better,” she said.

“We used to not have backtesting, but people are used to it. They like to know how things have performed. It seems like a reasonable thing to want to know what happened, but it doesn’t mean it’s going to happen,” she said.

Moderate upside

Investors who would be really bullish on the underlying would probably opt to buy the ETF outright, she said.

“Why would you hold something for 15 months and take the credit risk and the cap? If you’re bullish, you can access the fund directly and hopefully make more than the cap,” she said.

It is only for mildly bullish investors that the notes offer value with a potential for outperforming the ETF.

“The leverage is really the selling point. If you don’t expect this fund to go up a lot and if you want to get a higher return, this note works to your advantage,” she said.

Barclays is the agent.

The notes will price May 30.

The Cusip number is 06741VW40.

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