Barclays’ $5.35 million contingent income autocalls on KraneShares ETF pose reinvestment risk

By Emma Trincal

New York, Jan. 27 – Barclays Bank plc’s $5.35 million of contingent income autocallable securities due Jan. 25, 2024 linked to the KraneShares CSI China Internet ETF should benefit from macroeconomic tailwinds, an adviser said. But the duration of the notes could be as short as three months given the high likelihood of an automatic call. As a result, investors need to really consider the potential reinvestment risk, which is greater than the market risk at maturity, he said.

Investors will receive a coupon of 14.5% per year, payable quarterly, if the ETF closes at or above its 60% downside threshold on the relevant observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The securities will be called automatically at par if the closing price of the underlying ETF is greater than or equal to its initial price on any quarterly review date.

At maturity, the payout will be par unless the ETF finishes below its downside threshold level, in which case investors will be fully exposed to the decline of the fund.

Declining dollar

Investors in the notes may benefit from two tailwinds regarding China, said Jeff Pietsch, founder of Capital Advisors 360.

“After a peak in October, the U.S. dollar is now falling. Investors are assuming that the Fed is near the end of its hawkish policy while the rest of the world, which is earlier in the tightening cycle, is still catching up.

“A declining dollar is bullish for international equities,” he said.

Non-U.S. equity funds, such as those tracking the performance of the Euro Stoxx 50 index, the MSCI EAFE index and the MSCI Emerging Markets index, have all posted strong returns since last fall, he noted.

“Global portfolios have done really well in part due to this currency effect,” he said.

A weakening of the U.S. dollar will typically enhance the returns of foreign equity funds. That’s because the foreign currency will buy more dollars when the shares are converted, which will increase the value of the U.S. dollar-denominated shares.

End of zero-Covid

The second “tailwind” is the reopening of the Chinese economy, he said.

“After last year’s protests, the Chinese government has capitulated. They’ve relaxed their zero-Covid policy. At first, the reopening may have a negative impact because people will be sick, and it may disrupt supply chains. But soon it will be a source of growth. When the U.S. and other countries reopened from the shutdowns, the recovery was impressive. The revitalization of a major economic power like China will be a huge tailwind.”

Those two bullish factors – a weaker dollar and China’s reopening – should hold next year, he said.

Technical outlook

From a technical perspective, the share price of the ETF should also continue to rise, he added.

The ETF closed at $34.85 on the trade date, or 10.6% off its 52-week high of $39 hit in February.

The price has doubled from its one-year low of $17.22 in October.

“I don’t think we can conclude that the ETF is overvalued if you look at it over a longer period,” he said.

The fund, which launched in 2013, has lost more than two-thirds of its value since its all-time high of March 2021 at $105.

“If we’re so close to the most recent highs, it’s only because the stock was over punished previously,” he said.

High volatility

At the end of 2020, the Chinese government cracked down on big technology companies, in particular Alibaba Group Holdings Ltd. whose chief executive, Jack Ma went missing. Over the next two years, the stock plunged by 82%. Alibaba is the second largest holding in the underlying ETF with an 8.3% weight. The top name is Tencent Holdings Ltd. with a 10.65% weight.

The KraneShares CSI China Internet ETF has only 34 components. Its implied volatility is 47.5%.

“There’s a lot of risk, no doubt about that,” said Pietsch.

For investors in the notes, the main question is whether the 60% barrier will be defensive enough against wide price swings.

“Based on the two macro tailwinds I just mentioned, I believe that you probably have ample barrier protection but you’re still taking on some risk,” he said.

Call risk

The 14.5% coupon was attractive for clients seeking income. One way to reduce the risk was to position size the investment, he said.

“If you’re interested in that coupon and want to reduce your capital risk, maybe you should make a small allocation to the alternative income portion of your portfolio,” he said.

One caveat of the notes was the autocall. As the structure lacks any call protection, the first call could occur as early as April, he observed.

“If you want to collect as much as possible, you hope the price will stay between 60% and 100%. That would be the ideal outcome,” he said.

But such outcome was unlikely.

“The risk of being called is greater than the barrier risk,” he said. “This short-term investment carries a high reinvestment risk.”

While an autocall is not as punitive an event as losing capital at maturity, it may not be ideal for advisers and clients alike, he said.

“Chances are you’re going to have to find something else in three months,” he said.

“I like the notes, but it should be limited to a small allocation, one that goes to the alternative income portion of the portfolio.”

Barclays Capital Inc. is the agent. Morgan Stanley Wealth Management is the dealer.

The notes settled on Wednesday.

The Cusip number is 06748D618.

The fee is 1.75%.

© 2015 Prospect News.
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