Barclays’ $14.46 million notes on S&P 500 offer principal protection over intermediate term

By Emma Trincal

New York, Dec. 5 – Barclays Bank plc’s $14.46 million of 0% capped notes with principal return at maturity due June 2, 2025 linked to the S&P 500 index should appeal to risk-averse investors as the structure removes all downside risk, a financial adviser said. But most investors would do just as well, if not better with a simple buffer in order to capture more upside, a second adviser noted.

The payout at maturity will be par plus any gain in the index, subject to a maximum payout of par plus 22%, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, investors will receive par.

Capital preservation

The notes provide full principal protection over a relatively short period of time, observed Carl Kunhardt, wealth manager at Quest Capital Management. There was an appetite among some investors for full protection against market risk, he added.

“I do like it. Principal protection. That sets the objective. It’s not growth. It’s not income. It’s for capital preservation,” he said.

“This gives me equity exposure without the equity risk.

Usually, notes protected at 100% tend to be offered on much longer tenors, he said.

“It’s only two-and-a-half years, not five years. You have to be able to pay for the protection. So of course, you’re going to be capped.”

But the annualized return exceeded Kunhardt’s capital markets assumptions.

“We expect 7% a year and you get 8.5%. Plus, you have no risk.

“Your only risk is Barclays. But Barclays is a major bank,” he said.

It’s the game

One downside of principal-protected notes in general is their tax treatment. Investors have to pay interest income each year even though they only get paid at maturity, according to the “tax considerations” section of the prospectus. In addition, any gain is treated as ordinary interest income rather than capital gain.

“It’s an aggravation for all people. But you have no equity risk. Nobody likes the tax treatment. But every game has rules, and if you don’t like the rules, don’t play the game,” he said.

“Also, it’s not like you’re going to put 1 million bucks into this note.”

Mid-term and cap

Another financial adviser said that the full protection came with an expensive price tag, eating up too much of the return potential.

“If you want full protection on the downside, you have to be able to give up something on the upside. Unfortunately, I think you’re giving up too much,” this adviser said.

He first pointed to a few “positive” aspects of the deal, such as the single underlier, the use of a very well-recognized index and a “solid” issuer.

But the cap was an issue.

“This is not a long-term note. It’s intermediate. I’m not sure it’s such a good thing because if you had a longer tenor, you wouldn’t have a cap. Here they cap your upside even though you’re unlikely to have large losses,” he said.

Buffer preferred

He explained why he made that assumption using back-testing data on the S&P 500 index.

Over any two-and-a-half year rolling period since 1950, the S&P 500 index has finished negative only 17% of the time, he said.

“I think a 15% or 20% buffer would be just as good,” he said.

The chances of a decline by 20% or more is only 6.4%, he said.

While any frequency of loss over 5% has to be explained to clients, the risk was not significant, he added.

“There’s an argument to be made for full principal protection. If you have clients who want to exit the equity markets out of fear of losses, that’s a good way to keep them invested,” he said.

“But statistically speaking I only have a 17% chance of losing money. And even if the market is down 20%, if I have a 15% buffer, I only lose 5%. I don’t know any client who’s going to be disappointed with that.”

Opportunity cost

This adviser also looked at the statistics regarding the upside. He found that 52% of the time during the rolling periods, the S&P 500 index closed above the 22% cap.

“You have a 52% chance to underperform the index. Clearly, you’re leaving too much off the table,” he said.

To sum it up, investors had a 17% chance of beating the market on the downside but at the cost of giving up gains more than 50% of the time.

“It’s just not competitive,” he said.

“I can understand that it may be appealing to some clients from an emotional standpoint. But it makes no economic sense.”

Wells Fargo Securities, LLC and Barclays Capital Inc. are the agents.

The notes settled on Friday.

The Cusip number is 06749N2Z4.

The fee is 2.975%.

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