Barclays’ five-year buffered SuperTrack notes on Russell show plain-vanilla, defensive play

By Emma Trincal

New York, May 24 – Some investors prefer simple structures with limited features if the product can match their main objective, said Suzi Hampson, head of research at Future Value Consultants. Such is the case of Barclays Bank plc’s 0% buffered SuperTrack notes due May 31, 2024 linked to the Russell 2000 index.

The payout at maturity will be par plus any index gain, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 20% and will be exposed to any losses beyond the buffer.

“Here’s a basic, easy to explain product. It’s a market-linked exposure except for the buffer. But the upside is similar to a fund,” she said.

Strong buffer

She pointed to the main strength of the structure.

“This one doesn’t have leverage so it will never outperform on the upside. It’s always going to pay you less since you’re not getting the dividends,” she said.

But investors buying this product are not chasing returns, she added. Their primary goal is to protect their investment.

The buffer will cushion the losses. The dividend payment – 5.8% for five years based on a 1.16% dividend yield – will also act as a “cushion” but for a lower amount.

“If the underlying finishes down by less than this dividend amount – or if it closes negative but above 94.2% – the product will return 100% of principal but you’ll get less than what you would have earned in the ETF, since you’re not getting the dividends,” she said.

“Anything below 94.2% however, the note is going to outperform. So, while you can’t beat the index on the upside, you can certainly outperform on the downside depending on the extent of the index decline,” she said.

No leverage, no cap

Investors in the notes must be willing to give up upside leverage in order to get a sizable buffer, she said. By doing so, they also manage to get unlimited upside exposure.

“Giving up the leverage allows you to avoid having to cap. It’s a choice. Some people can’t put up with a cap,” she said.

“With this note, you can benefit from a rally the same way you would with an ETF, except for the dividends.

“Having some gearing would allow you to catch up with the dividends. But this is not the choice investors are making with this product.

“They want unlimited upside along with a buffer.”

Bullish, non-exotic

“So, this is an interesting note: it’s bullish and it reduces the risk at the same time,” she said.

The simplicity of the structure also offers some benefits. For one, it made it easier to compare with an investment in the index fund.

“It’s a very basic product,” she said.

“It feels more straightforward, closer to a tracker.

“If you compare this with other product types, for instance an autocallable, it’s quite different as our simulation will show.

“It’s also much easier to explain to an investor how it fits into a portfolio.”

Stress testing

Future Value Consultants offers stress testing on structured notes. The model calculates the probabilities of occurrence of outcomes pertaining to a specific product and structure type.

The simulation is based on a neutral scenario calculated from the risk-free rate, dividends and volatility of the underlying.

Four other market assumptions are presented in each report. Those are bullish, bearish, less volatile, more volatile.

Hampson examined one of the 29 tests of the report, picking the capital performance tests table. The three tests or possible outcomes are: return less than capital; return exactly capital; and return more than capital, in other words losses, principal back only and gains, respectively.

Buffer value

The probabilities attached to the “return exactly capital” bucket corresponds to the index finishing negative but within the buffer zone, or down by 20% or less. Those probabilities help measure the usefulness of the buffer. Under the neutral scenario, the buffer will kick in 17.8% of the time, according to the report.

“It’s always difficult to have an idea of how the buffer may affect your return. The probability attached to the “return exactly capital” bucket helps investors get an idea of what they’re getting from a buffer,” she said.

Obviously, this probability will fluctuate depending on the type of market environment. In the bear market for instance, investors will take advantage of the buffer at a much greater rate – 21.5% of the time.

“It makes sense. As the market goes down more, the buffer becomes more important,” she said.

Market-dependent

The “return more than capital” bucket showed more dispersion in the probabilities.

“The odds of making money vary widely from one market type to another with this product,” she said.

“Unlike an autocall with many moving parts, there isn’t much going on here. The main factor will be the market itself, which explains the great disparities between the various scenarios.”

In contrast, it is the structure rather than the performance of the underlying that will impact the return with an autocallable product, she added.

The outcomes themselves are very different. Autocallables pay a fixed or contingent coupon or just a call premium. In any event, the gains are limited.

“Our simulations with autocalls are mostly centered around the probabilities of calling on the first call date and the chance of getting paid, including when and how often,” she said.

“Here on the other hand, you’re much more dependent on the underlying performance.

“Therefore, the dispersion in probabilities is much wider.”

For instance, the notes, according to the report, give investors an 82.3% chance of getting a positive return in the bull market simulation versus 57.31% in the neutral scenario.

Growth assumption, payoff

This is true even with the very muted growth assumptions generated by the firm’s methodology.

“Our model runs conservative growth rates in order to facilitate comparisons between various products of the same structure type,” she noted.

As an example, the Russell 2000 index is given a 7.6% growth rate in the bull scenario. The bear market shows a muted negative 4.5% annualized performance.

The table also includes average payoffs by market types. Again, the discrepancies in average payout between the various market assumptions are far greater with this product than they would be with an autocallable, she noted.

The average gain for instance will be 35.3% in the neutral scenario versus 60.8% in the bull market, according to the report.

Back testing

In addition to its Monte Carlo simulation model, Future Value Consultants offers back testing analysis.

“Back testing results are pretty encouraging. But they’re not forward-looking so investors need to be cautious,” she said.

“In addition, the bull market we’ve had in the past decade has enhanced the picture.”

Gains have been recorded 86.37% of the time in the past 15 years, according to the report. The frequency of capital loss was only 1.83%. The average loss when it occurred was only 6.9%.

“It’s not a huge loss. That’s because you have a buffer rather than a barrier.”

In conclusion, she said that the simple structure offered many benefits for investors who need to preserve their capital while gaining exposure to the U.S. small-cap stock market.

“It’s a lower risk way of getting exposure to U.S. equity in a portfolio. You’re reducing the risk and the volatility of returns rather than using a fund or an ETF,” she said.

“For people concerned about market risk, it’s a reasonable alternative to a fund.”

Barclays is the agent.

The notes will price on May 28.

The Cusip number is 06747MT63.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.