Barclays' buffered digital notes linked to Russell offer chance of high return in slow market

By Emma Trincal

New York, Aug. 29 - Barclays Bank plc's 0% buffered Super Track digital notes due March 5, 2013 linked to the Russell 2000 index offer a digital payout structure that should appeal to moderately bullish investors, sources said.

Even if the small-cap benchmark grows moderately, for instance in the single-digit range, investors will outperform the index, they noted.

If the index return is positive, the payout at maturity will be par plus a digital return of 16% to 19%, according to a 424B2 filing with the Securities and Exchange Commission. The exact digital return will be set at pricing.

Investors will receive par if the index falls by up to 10% and will lose 1% for every 1% that it declines beyond 10%.

All or none

"I like the digital feature specifically. It's an all-or-nothing. You know exactly what you're going to get on the upside," said Michael Kalscheur, financial adviser at Castle Wealth Advisors.

"I like this particular format better than a 200% participation where you get two times the index return up to a cap.

"If the index is up 0.2%, under the 200% participation structure you get a whopping 0.4%.

"Here, your return is 16% over an 18-month period. It's competitive."

Carl Kunhardt, wealth adviser with Quest Capital Management, said he likes the simplicity of the payout.

"I'm comfortable with the digital return," said Kunhardt.

"A digital coupon on a fairly exotic underlying with a made-up index wouldn't appeal to me. But this one is straightforward and easy to understand.

"The index is up or down at maturity. It's point to point. The upside is capped. It's easy to explain.

"You're giving up some of the upside, but we're in a volatile environment, so it's expected."

Reasonable cap

The structure does not offer investors any participation in the index growth, as stressed in the prospectus' risk section.

As a result, the digital coupon represents the maximum return and is the equivalent of a cap.

But the advisers said that a 16% to 19% range for the term - the equivalent of a 10.6% to 12.6% annualized return - is acceptable given the 10% buffer.

Kunhardt said that the cap is unlikely to generate a big opportunity cost.

"Would the Russell exceed 10% to 12% a year? Yes, in a normal market. But we're not in a normal market. We're expecting more muted returns," said Kunhardt.

"Even though it's small cap, I don't think it will be out of character to expect annualized returns around 10%. In fact, an 8% to 10% range would be more realistic."

Kalscheur said that with an underlying index that is more volatile than the S&P 500, he would have "hoped" for a higher cap. Yet, he is still satisfied with the maximum return.

"Even 16% to 19% works out," he said.

Not a cliff

The cap is acceptable given the existence of a buffer, a downside protection mechanism that is widely viewed as more protective than a barrier.

"It's a buffer; it's not a cliff," said Kalscheur.

"If the index is down 20% you're only losing 10%. If it's down 30%, you're losing 20%.

With a 90% barrier - which brings a 10% soft protection - a loss of 20% in the index would generate a 20% loss of principal, not 10%.

"It gives you protection all the way down, which is a key factor of risk reduction," Kalscheur said of the buffer.

For Kunhardt, the buffer is consistent with his market outlook.

"I don't believe that we will fall into a recession," he said.

"You have a 10% barrier. I don't see a lot of downside risk.

"I always tell my clients 'If we're doing something that's keeping you up at night, it's not good. We need to get out of it.'

"This type of product is unlikely to keep my clients up at night. So I like it."

The term, the choice of the underlying index as well as the simplicity of the structure are also seen as positive aspects of the deal.

"It's short term. I'm very comfortable with an 18-month," said Kunhardt.

"It's a very plain-vanilla index, easy to track and easy to follow."

"You have a respectable protection, a respectable company, an understandable underlying index, and it's only 18 months. I like the offering," said Kalscheur.

"If you're not worried about the market or if you're only moderately bullish, it's a great way to dip your toes or get exposure to the market by minimizing your risk," he added.

The notes (Cusip: 06738KSY8) are expected to price Tuesday and settle Sept. 2.

Barclays Capital Inc. is the agent.

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