Barclays’ $948,000 buffered notes on two equity ETFs seen as handy for non-U.S. allocation

By Emma Trincal

New York, June 15 – Barclays Bank plc’s $948,000 of 0% buffered dual directional notes due June 13, 2025 linked to the performance of the iShares MSCI Emerging Markets ETF and the iShares MSCI EAFE ETF offer terms that may be useful for investors seeking to allocate to international equity markets. But as the U.S. markets continue their relentless rally, the hard part will be to decide how much should move outside of U.S. equity buckets in an effort to diversify, advisers said.

The payout at maturity will be par plus 1.2 times any gain in the lesser-performing ETF, according to a 424B2 filed with the Securities and Exchange Commission.

If the lesser-performing ETF falls by up to 15%, the payout will be par plus the absolute value of the return of that ETF.

Otherwise, investors will lose 1% for every 1% decline of the lesser-performing ETF beyond 15%.

Plain vanilla

“The terms are really interesting. You’re going to outperform no matter what the market does. This is pure equity exposure, nice and clean, no cap,” said Steve Doucette, financial adviser at Proctor Financial.

The non-payment of dividends is always a shortcoming for structured notes investors. But in this case, the opportunity cost was relatively modest, and the period limited in time, he noted.

“International indices tend to pay more dividends. But the yields on these two aren’t huge,” he said.

The Emerging Markets ETF and the EAFE fund show dividend yields of 2.25% and 2.35%, respectively.

In comparison, the Euro Stoxx 50 index has a 3.25% dividend yield while the S&P 500 index yields only 1.45%.

“Two years is not a long time to forego the dividends. And you have that 20% leverage. You’re going to make far more in gains that you would lose in dividends,” he said.

“I like these plain-vanilla simple notes.”

Uncapped return

For investors looking for international equity exposure, the note was appropriate.

“If you want to diversify your portfolio or add to your current allocation to this asset class, you should own something like that,” he said.

Unlike many growth notes shorter than five-year maturities, this one had the advantage of providing unlimited returns on the upside, he noted.

“The no-cap is one of the best things. You can be really bullish. If international markets come screaming out, you’ll be able to capture the upside,” he said.

“But you can also be wrong. That’s where the absolute return and the buffer come into play.”

Defined outcomes

The terms of the notes gave investors some level of “control,” but with one caveat.

“The scary thing with structured notes, which is also why people buy them, is the defined outcome on a specific date. You might be forced down based on the performance of a day, a week, or a month,” he said.

“When you have a short-term blip, it’s usually due to technicals, not fundamentals. Big declines are often technicals. Occasionally it’s fundamentally driven, but you’re talking about major events that affect the future of the economy for everybody. Things like war or Covid.”

Over two years, the 15% hard protection may not be sufficient to prevent losses, he said.

“But at least you’ll always outperform the market. You have everything you need for that: buffer, leverage and no cap without mentioning the absolute return.”

Naturally, noteholders are bound to underperform the best-performing ETF since the exposure is tied to the worst of the two. For investors considering the notes for their equity portfolio, however, deciding how much to bet on non-U.S. versus U.S. was a key factor to consider.

U.S. or non-U.S.

“After the tech runup here in the U.S., will tech revert back to the mean? Will non-U.S. assets outperform the U.S.? It’s all about timing,” he said.

“One thing for sure is that when emerging markets rally, they generate huge returns.”

An example was the MSCI Emerging Markets fund jumping 36.5% in 2017.

But the U.S. markets have outperformed international markets (as measured by the two underlying ETFs) eight out of the past 10 years, according to Morningstar.

“It’s hard to tell how long the U.S. will continue to beat every other market. But at some point, the mean reversion law will play out,” he said.

“Since Covid, we’ve been bringing back home our supply chains. But we’re in a global economy. In doing that, we’re paying more to produce our goods. It’s going to affect our competitiveness,” he said.

Another factor that may negatively impact the relative performance of U.S. versus international markets was demographics.

“Look at emerging markets. Those countries have a population that’s growing well beyond ours. If they have consumer-driven economies, they should be doing better,” he said.

Those economic and demographic trends, along with the market’s tendency to revert to the mean, have led this adviser to be bullish on the asset class.

“You have to be invested in international markets and this note is a pretty good way to do it,” he said.

Downside

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said the notes offered many attractive features.

“On the downside, I typically prefer larger buffers. On a two year, a 20% buffer would have been optimal for me. But I like the absolute return component to this note. You just have to be willing to sacrifice a little bit of the buffer for the absolute return. That’s a tradeoff I’m comfortable with,” he said.

Correlation

The worst-of added some risk. But such risk was limited, he said.

“Your risk is driven by low correlations, and I don’t think correlations are that low right now,” he said.

The lower the correlation between the two ETFs, the greater the potential for one of the two to fall beyond the buffer level.

The coefficient of correlation between the two ETFs is 0.86 with 1 being perfect positive correlation.

“Those two underlying are not negatively correlated. Historic correlations do not mean much right now anyway because it will change over the course of the two years,” he said.

“We’re at a time where there is so much uncertainty about the economy that most markets have high correlations.

“I don’t expect those two funds to move in opposite directions.”

On the upside the combination of leverage and the absence of any cap was attractive.

“This is really interesting especially over a two-year term. I like the fact that there is opportunity for more upside. Both the return enhancement and the no-cap make it possible,” he said.

Small allocation

Medeiros said his outlook on equities was “cautiously optimistic” at this point.

The terms of the notes offered some flexibility to accommodate different views.

“In this current environment, it’s difficult to make a call as the markets may turn in different directions very quickly.”

While high correlations between asset classes reduce the risk associated with any worst-of exposure, they may also add to the overall market risk.

“We had a very strong run in the U.S. markets. If we have a pullback, there is also a greater risk of contagion across different regions,” he said.

Medeiros said he found the product relatively attractive.

“I like the absolute return. The buffer is fine. The no-cap is definitely appealing.

“It’s a handy tool if you want to allocate to this asset class.

“But given the world we’re in with the uncertainty in the markets, I just wouldn’t overweight it,” he said.

Barclays is the agent.

The notes settled on Monday.

The Cusip number is 06745MEG9.

The fee is 1%.

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