Barclays' two-year notes linked to commodities basket offer 80% protection for mild bulls

By Emma Trincal

New York, April 18 - Barclays Bank plc's 0% notes due April 23, 2013 linked to a basket of commodities offer diversification and partial principal protection for bullish investors who want to play the commodities market with less risk, sources said.

The basket includes Brent crude oil with a 15% weight; gasoline RBOB, heating oil, copper, nickel and gold, each with a 10% weight; and corn, cotton, soybeans and sugar, each with an 8.75% weight, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 200% of the basket return if the basket gains, subject to a maximum return of 45% to 60% that will be set at pricing.

Investors will be exposed to the decline if the basket falls, subject to a minimum payout of 80% of par.

"I haven't seen something like that in a while. You basically get 80% protection, a diversified basket and a pretty high cap for a two-year. Not bad," a sellsider in New York said.

80% protection

For financial advisers who face a scarcity of principal-protected notes, this product offered some - although not 100% - downside protection. Still, the feature was seen as appealing by some.

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said, "I really like the 80% principal protection a lot."

Kalscheur said that creditworthiness is always his main consideration when selecting a structured note. In this case, he said that he was comfortable with Barclays' credit risk. "Barclays is at the top of the league. It's probably my number one from a backstop standpoint."

Diversified basket

Kalscheur added that he also liked the underlying basket, which diversifies about equally across energy, metals and agriculture.

"We routinely recommend the DBC to our clients," he said, referring to the PowerShares DB Commodity Index Tracking exchange-traded fund. "But the DBC is heavily weighted toward oil products. It has more than 50% in oil.

"With this basket, oil is just one-third of the portfolio. I like it better, especially with oil trading up over $100 already."

Not Armageddon

Kalscheur said that the 45% to 60% cap "makes sense."

"You're giving up some of the upside for the downside protection."

He added that the cap was designed for investors who anticipate higher inflation leading to higher commodities prices. But given the cap, investors holding this view have a moderately bullish outlook on commodities, he noted.

"It's a bullish bet but not an Armageddon bullish bet," he said.

"If you worry about hyperinflation, if you expect commodities prices to jump up through the roof, then this is not the right product for you.

"But if you see the commodities prices going up 10%, 20% over the next two years, then this is the perfect vehicle."

The structure also presented another advantage, this adviser said: simplicity.

"It's easy to explain to the client. You only have 10 things. Most people know what copper is, what corn is."

Liquidity risk, fees

Kalscheur said that liquidity risk was more of a concern. "If you need to take that money out 12 months from now, then you shouldn't be investing in these notes because chances are you won't be able to redeem them prior to maturity.

"But this is a known risk. You know full well you're in it for two years."

Kalscheur found the notes attractive, but he said he would also need to take cost considerations into account - although they do not rank as high on his priority list as creditworthiness and risk-reduction factors.

"We would need to find out what the price is before we pull the trigger on it," he said.

'Complete sham'

Michael Frankfurter, managing director at Cervino Capital Management, a Commodity Trading Advisor, said that he did not like this product, along with structured notes in general.

"These things are silly. It's a complete sham. You can easily replicate this with futures and options," he said.

The fact that the payout is determined at maturity, or in options language, when the option expires, was a major drawback, according to Frankfurter.

"It's based on a European option that expires at the end," he said.

"It should be an American option. Any option that you can exercise anytime you want is far superior to one that is constrained to expire on the expiration date."

Frankfurter added that the structure as it is offers no flexibility to investors.

"I could replicate that trade with options and futures with much more flexibility and at a much lower cost," he said.

"I can buy a basket of futures [for all those commodities] on margins. I don't have to be capped. I can control my exposure. I can define the amount of leverage I want. And for the protection, all I have to do is buy put options."

The notes (Cusip: 06738KHN4) were expected to price Monday and settle Thursday.

Barclays Capital Inc. is the agent.

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