Barclays’ fixed-coupon autocallables on Invesco QQQ seen as too short amid uncertainty

By Emma Trincal

New York, May 7 – Barclays Bank plc’s 14% fixed-coupon autocallable securities due Nov. 13, 2020 linked to the shares of the Invesco QQQ Trust, series 1 offer the classic advantages of a reverse convertible with its short maturity and fixed coupon. Moreover, the exposure to a broad and resilient benchmark, downside protection and monthly automatic calls could also be seen as positive features. But for advisers, the culprit is the six-month term amid uncertainty over the coronavirus outbreak and its detrimental impact on the economy despite the beginning of the re-opening phase in some states.

Interest is payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

If the ETF closes at or above its initial price on a monthly determination date, the notes will be automatically called at par plus the coupon.

If the ETF finishes at or above the 85% downside threshold level, the payout at maturity will be par plus the final coupon. Otherwise, investors will receive a number of the underlying shares equal to $1,000 divided by the initial share price or, at the issuer’s option, the cash equivalent.

Barrier

Matt Medeiros, president and chief executive of the Institute for Wealth Management, found the deal too risky.

“I like the coupon associated with this note,” he said.

“However, because of the short timeframe, it’s not something I would do especially with just a barrier on such a volatile underlying.”

Too short

The stock market has shaken off some of the bad economic news this week, especially regarding unemployment. But it does not mean that a recession will be avoided.

“There are still a lot of headwinds in this market right now and we’re going through a period of unprecedented uncertainty before going back to normal. What is the new normal?

“Volatility is extreme. It’s hard to say what the economy or the job market will look like in six months.”

An additional 3.17 million weekly initial jobless claims came out on Thursday, higher than the 3 million consensus, bringing the total of unemployed Americans to 33.5 million over the past seven weeks.

The market however reacted positively as the jobless claims were less than the previous week.

Call assumptions

The fact that the notes may be called each month, starting next month, should not be seen as a risk mitigation factor, this adviser said.

Some investors, he noted, see autocalls as an arbitrage between the reinvestment risk and the market risk. When the notes are called, there is no more chance of losing principal. Investors only have to worry about reinvesting the proceeds.

“I don’t see it that way at all. I don’t look at those call options that way,” he said.

“You have to buy something with the expectation that you’re going to hold it until maturity.”

Counting on a call to reduce the risk of breaching the barrier at maturity was too risky a strategy in his view even if the odds of an early redemption are high.

“You can’t get in expecting that you’ll get called in one or two months. You don’t know if it will happen,” he said.

November surprises

If the notes mature, the six-month tenor is adding more risk of losing principal at maturity.

“It’s not a very deep barrier.

“You have the Elections coming up in six months just at maturity.

“We may be in the midst of an economic downturn due to the pandemic.

“There are too many headwinds to invest in such a short timeframe,” he said.

Not core

The notes although designed for income would be too risky for a fixed-income portfolio.

Medeiros is more interested in asset allocation over the long term.

“I look at QQQ as a core holding with a higher standard deviation.

“This note would make more sense to me over a longer holding period, anything between three and five years for instance.”

Risk reward

Steve Doucette, financial adviser at Proctor Financial, did not like the risk-adjusted return.

“Of course, it’s a very neat coupon. In one month, you get almost what you get with a CD in one year,” he said.

The average one-year certificate of deposit among the 12 top-yielding CDs shows a 1.38% annual yield, according to Bankrate.

“But do you want to expose yourself to an unlimited downside to QQQ over six months?

“It doesn’t give you time to rebound.

“Maybe if you extend the duration. But as it is, you have an upside capped at 7% since it’s a six-month and you can lose 100%.

“Granted.... If you don’t get called, you get your entire coupon so you can use the 7% against your losses.”

But then investors earn nothing. Their risk return profile would be zero return for a maximum loss of 93%, he noted.

“Not much to be excited about.”

“It’s not unlikely that QQQ would drop 30% or 40% in six months.

“I can’t imagine why you would take all that downside for a 7% coupon,” he said.

Not fixed-income

Even if after one month, investors in the note, if called, would have earned about the same thing as a CD buyer in a year, the risk profile between the two instruments are too different to allow for the use of the notes in a fixed-income portfolio.

“Even though it’s a fixed rate, it’s not fixed income. You’re risking too much on the downside to use it in your fixed-income portfolio,” he said.

Resilient stocks

Technology has fared better than other sectors so far this year. But it’s hard to tell if the trend will continue should the market fall again as it did in February.

“Tech stocks have recovered better. But it’s hard to value them. Stock prices should reflect the value of future cash-flows. But in this environment, it’s very hard to analyze anything, let alone make predictions,” he said.

One better way to bet on the sector would be to extend the term.

“Six months is too short. In six months, we could be down. You want to have enough time to recover from a pullback,” he said.

Barclays is the agent with Morgan Stanley Wealth Management as a dealer.

The notes will settle on May 12.

The Cusip number is 06747PSS9.

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