Barclays’ market-linked step-up notes tied to Nikkei 225 to outperform in modest growth

By Emma Trincal

New York, Jan. 16 – Barclays Bank plc plans to price 0% market-linked step-up notes due January 2020 linked to the Nikkei 225 index, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes at or above the step-up value – 116% to 122% of the initial level – the payout at maturity will be par of $10 plus the index gain.

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 16% to 22%.

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

Short-term

“This is purely a bullish play. You don’t have the downside protection. You’re giving up the dividends. But what you’re getting in exchange is this minimum return, let’s call it 9% a year,” said Jerry Verseput, president of Veripax Financial Management. He assumed a 118% step-up value.

“If you’re up a little bit, you get almost 10%. “If you’re looking for a short-term play then it’s the right thing.”

But Verseput said he prefers to invest in longer-dated notes.

“If I’m going to be exposed to Japan, or to equities in general, I prefer a longer time horizon just because anything can happen within two years,” he said.

“If the market is down, you have no downside protection.

“Assuming you want to get out early, it’s not very liquid. You’ll have a spread.”

Dividends

In addition, the lack of dividends limits the range of outperformance made possible by the step return.

Assuming a 1.5% yield, investors would give up 3% over the term of the securities, he said.

If the step-up return is 9% on an annual basis, the real range of index return, which allows the notes to outperform the market, will be between 1.5% and 9% a year, he added.

“I don’t know if it’s worth the effort. I’d rather buy the ETF and collect my 1.5% dividend with a highly liquid investment,” he noted.

“In this note you’re giving up liquidity for the benefit of outperforming but it’s in a narrow range and you have no downside protection.

“It’s not bad. But you have to be happy to get an incremental return if the index is up a little.

“It just happens not to fit my investment style.

“I prefer to play equities over longer timeframes.”

Sound structure

Another adviser said he liked the structure of the notes, which may be called market-linked step-up or jump securities depending on the distribution. Specifically he liked the opportunity of collecting the step return without being capped above that level. The mix of a digital return and unlimited upside participation was very attractive, said Steven Foldes, chairman of Evensky & Katz / Foldes Financial Wealth Management.

“We like these kinds of notes a lot. We have a similar note in our portfolio right now and it has done very well.”

“The idea of generating a nice return on a short period of time from an asset class that’s only showing a marginal performance is very compelling,” he said.

Good experience

He explained that just after the Brexit vote, he purchased a 19-month note similar to this one but linked to emerging markets with a minimum guaranteed return of 22%.

“If an asset class has not done very well and you want to play the reversal but you’re not sure how strong the performance is going to be, these notes are very effective,” he said.

“At the time, emerging markets had done nothing for years. We thought a rebound was overdue. We did not have any buffer or barrier but we were not concerned about the downside. We were concerned about a very modest performance, which is why we like the boost provided by those digital payouts,” he said.

“Emerging markets took off. And since those products are not capped we’ve been very fortunate in our timing. This note is up 40% since we bought it.”

Strong rally

The case for Japanese stocks would be different however.

“First we typically invest across countries, not on a single country,” he said.

Also unlike buying emerging markets in the middle of 2016, getting exposure to Japanese stocks today hardly qualifies as a contrarian play.

“Japan has performed really well. That would give us some concern. It’s coming off a very high year,” he said.

The Nikkei 225 index gained over 20% last year. It is up 5.2% for the year, which is about two weeks.

Same rationale

But for investors with a mildly bullish view, the same investment would be justified.

“If you think that in the next two years, the Nikkei is not going to go up that much, if you expect returns to be modest you can certainly take advantage of a 9% minimum coupon as well as the uncapped upside,” he said.

“This view is defensible as long as you’re not too bullish.

“But even if the index is up a lot, you’re still getting the full upside.

“The tradeoff is to give up the dividends for this minimum return without sacrificing the upside. As long as the index is up marginally you win.

“I like this kind of concept.”

BofA Merrill Lynch is the agent.

The notes are expected to price in January and settle in February.

© 2015 Prospect News.
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