Buffer plays key role in Barclays' S&P 500-linked notes, analyst says; Goldman note highly unusual

By Kenneth Lim

Boston, May 16 - A buffer made all the difference between two accelerated notes by Barclays Bank plc that are linked to the S&P 500 index, said structured products analyst Suzi Hampson of Future Value Consultants.

Meanwhile, the Goldman Sachs Group, Inc.'s principal protected notes linked to a basket of currencies against the euro is an unusual product because of its structure and its underlying components, Hampson said.

Barclays notes link to S&P 500

Barclays recently launched two series of zero-coupon return enhanced notes due June 4, 2009 linked to the S&P 500 index.

At maturity, the first note will pay par of $1,000 plus double any positive return on the underlying index, capped at a maximum total payout of 113% of the principal. If the index ends unchanged or lower by no more than the buffer percentage of 10%, investors will receive par. For every 1% that the index ends lower by more than 10%, investors will lose 1.1111% of the principal.

The second note has a similar structure, except that it has a higher participation rate if the index increases and it has no buffer.

At maturity, the second note will pay par of $1,000 plus triple any positive return on the underlying index, capped at a maximum payout of 118.75% of the principal. Investors will lose 1% for every 1% decline in the index.

Buffer improves rating

Based on Future Value's assessments, the buffered notes received a higher score than the non-buffered ones, even though the non-buffered product had a higher participation rate and cap on the upside.

The buffered note had an overall rating of 7.25 out of 10 with a low risk score of 1.94, a lower risk score being a less risky product. But the non-buffered note had an overall rating of 7.05 with a risk score of 4.1.

Future Value rates the products based on their value, simplicity and potential returns, and assesses the risks based on probabilities of principal loss as well as volatility.

The buffer "does have quite a big effect on the risk that's attached to it," Hampson explained. "If you look at the one that doesn't have a buffer, it's got a 54.7% chance of getting more than a 15% return, but in exchange for that you've also got a 25.9% chance you're going to lose more than 5% of your principal ... So you have higher participation and a higher cap, and this is feasible by risking more of your capital."

"The 10% buffer, although it doesn't sound like very much, it makes quite a difference," she said.

Despite the disparity, both Barclays products offer better returns than a direct investment in the S&P 500, and investors should ultimately choose based on their risk appetites, Hampson said.

"I guess it would depend on your goal as an investor, how much risk they're willing to take," she said. "You're never going to underperform the index, but for an investor who normally just invests in the S&P 500, an accelerated upside with the same risk on the downside makes it quite attractive regardless."

Goldman notes unusual

Goldman Sachs' recently launched euro-linked product has an unusual structure and underlying components, Hampson said.

The Goldman Sachs notes are zero-coupon principal protected notes with a tenor of 24 to 27 months linked to a basket of eight currencies against the euro.

The maturity date will be set at pricing.

The basket comprises equal weights of the Brazilian real, the Russian ruble, the Indian rupee, the Malaysian ringgit, the Singapore dollar, the Mexican peso, the Australian dollar and the Norwegian krone. The basket's value increases if its component currencies strengthen against the euro.

If the basket return is less than 2% at maturity, the notes will return par of $1,000. If the basket return is between 2% and a step-up percentage between 14% and 16%, the notes will return par plus the step-up percentage. If the basket return is the step-up percentage and above, the notes will return par plus a participation rate of 1.4 times to 1.6 times the basket return.

The step-up percentage and participation rate will be determined at pricing.

Investors will receive at least par.

The product's link to the euro instead of the more typical U.S. dollar was interesting, Hampson said.

"They're usually linked to dollar, so part of the deal's attraction might be for investors who are afraid of the dollar, or want to get out of the dollar for whatever reason," she said.

The principal protected structure was also welcome.

"I don't know why, but there aren't that many principal protected products in the U.S.," she said. "In the U.K. we have a lot more principal products than capital-at-risk products, and most of yours seem to be linked to currencies."

The product's return structure also raised eyebrows because the participation rate changes across different ranges of the underlying return.

"It's almost like receiving a coupon if it's between 2% and 14%," she said. "If the basket rises 3% or 4% or 5%, then you're better on a product like this. However, if the basket rises massively, the advantage is less, and if the basket rises just 1%, you just get your principal back."

The basket of currencies appears to lean toward the BRIC bloc of Brazil, Russia, India and China markets, with the Malaysia ringgit and Singapore dollar possibly offering a proxy to the Chinese yuan, Hampson said.

There is no one rule on how the number of currencies in the basket affects the product's risk rating, Hampson said.

"If you have four currencies with really low correlation and eight with really high correlation, the difference isn't quite the same, but generally when you have more things in the basket, it tends to bring down the volatility," she said. "Not all the time, but it depends on what you put in the basket. But an investor might think, I've got eight chances rather than four and with less weighting on each one."

Notes at risk of underperformance

Investors in the Goldman notes will be taking a chance on underperforming other assets if the underlying basket does not perform as expected, Hampson said.

"The risk is a small growth in the basket, so if the basket only goes up by 1.9999%, you only get back your principal," she said. "If there's an increase of only 1%, the investor gets nothing extra, and it takes away the potential you can make in a cash investment, for example."

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