Barclays’ market-linked step-up notes tied to MSCI ACWI ex USA show limited tradeoff

By Emma Trincal

New York, June 6 – Barclays Bank plc’s 0% market-linked step-up notes due June 2019 linked to the MSCI ACWI ex USA index, offer little benefit over the equivalent exchange-traded fund, advisers said.

If the index finishes at or above the step-up value – 115.5% to 121.5% of the initial level – the payout at maturity will be par of $10 plus the index gain, according to a 424B2 filing with the Securities and Exchange Commission.

If the index is unchanged or gains by up to the step-up level, the payout will be par plus the step-up payment of 15.5% to 21.5%.

Investors will lose 1% for each 1% index decline.

Sweet spot

“The sweet spot of this is if the index stays relatively flat, if it’s not too volatile. It’s only the step-up that gives you value,” said Scott Cramer, president of Cramer & Rauchegger, Inc.

If the underlying finishes higher than the step-up, investors get the full index appreciation minus dividends.

“I guess if you’re bullish, at least you’re not losing the upside. The step is not a cap. But you’re not getting anything either,” he said.

On the other end, investors are fully exposed to any index decline, he noted.

Narrow range

Cramer did not see much advantage to investing in the notes compared to the ETF based on the index because the chances of outperforming are very limited and not worth the loss of liquidity and dividends.

“You’re betting that the index will be up anywhere from zero to 18%,” he said using the approximate mid-range of the step-up level.

“It’s a very specific bet. That’s for someone who thinks they’re smart enough to know what’s going to happen in two years,” he said.

No protection

Another problem was the absence of any buffer or barrier.

“You don’t have liquidity. Structured products give you some benefit for the illiquidity. It’s always a tradeoff.

“If I tie my money up for two years, I want to get something for it,” he said.

“I want to get some downside protection, some leverage.”

Cramer said that he understood the benefit of the step-up, a feature that enhances returns, but its limitation was that it only worked out under limited conditions.

“To benefit from the step, you need the index to go up a little bit. That’s it. It can’t go up too much. It certainly can’t drop,” he said.

“But your margin of positive outcome is so tight... It’s not worth the liquidity premium.”

Broad exposure

Michael Kalscheur, financial adviser at Castle Wealth Advisors, had a similar view on the structure although he said that he liked the underlying index.

The MSCI ACWI ex USA index, with 1,154 components, gives investors exposure to a wide range of stocks in international developed and emerging market countries.

“It has some aspects of the EAFE with countries like Japan, Australia, France, Germany, the U.K,” said Kalscheur.

The MSCI EAFE index tracks the return of developed countries but excludes the United States.

The ACWI also includes some emerging markets such as China, Brazil and South Korea, he noted.

“It’s a very broad worldwide index and we like that.’

Dividend loss

Kalscheur however said the advantageous terms of the note, which are mostly on the upside are not worth the loss of dividends.

The index has a dividend yield of 2.45%. Over two years, investors give up nearly 5%.

Assuming the step up is set at 18, investors will only benefit from the notes when the index is up to the step-level minus the dividends, or approximately 13%.

“That’s kind of my high-water mark to outperform: up to 13%. It’s such a small band to outperform, I don’t really see the point,” he said.

Return outcomes

The financial adviser likes to use backtesting to get an estimate of potential returns for a specific duration. While he did not have data on the MSCI ACWI ex USA index, he had performance tables for the MSCI EAFE index over the past 16 years.

“I think the EAFE can be roughly used as a proxy,” he said.

Based on this assumption, he found a probability of only 18.2% for the EAFE index to finish between 0% and 13% on two-year trailing periods since 2001.

“Having less than a 20% chance to outperform...that’s obviously an 80% chance to underperform,” he said.

“I just can’t really get excited about it.

In addition, the note lacked the conservative profile Kalscheur prefers to invest in.

“If we’re going to buy a structured note, we want the downside protection. If this one doesn’t have one, we’re just going to take a pass.

“It’s not always the case but with this note I would go for the index instead.”

BofA Merrill Lynch is the agent.

The notes will settle in July.

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