Interest rates house of the year: Barclays

Amit Agarwal

Barclays has had to cope with an increasingly risk-averse investor base within the context of historically low yields, but by emphasising simplicity and transparency, the bank has stormed ahead with its offering of innovative products this year.

An understanding that nervous investors require simple solutions in the current climate was the inspiration behind Barclays' expansion of its range of beta indexes to provide clients with global fixed-income market exposure through total return swaps. The indexes aim to give investors efficient access to those markets with minimal tracking error.

"A lot of asset managers track these indexes, so our product offering has been to sell total return swaps against the indexes instead of actively trying to trade around them to recover the beta," says Amit Agarwal, Hong Kong-based managing director at Barclays. "It is also far more efficient in terms of cost to be able to do it through a total return swap, because you don't have to go through a fund manager. This is likely to be one of the biggest developments in the Asian market. Cost pressures are likely to increase and a lot more fund managers and real money investors will look for cheaper alternatives to access beta."

Last year, Barclays launched the Barclays US MBS GNMA Excess Return Fund, which provides exposure to US mortgage markets in a yen-denominated format. There is now in excess of $213 million in the fund and its success can be attributed to the fact that investors in Japan have been seeking to diversify away from Japanese government bonds, according to the bank. "The US mortgage-backed securities market is an asset class they have been very keen to tap into," says Agarwal. "And returns from the GNMA fund are superior to Japanese government bond yields."

Barclays has provided access to its indexes in a variety of other ways: hedge funds, for instance, have used the Government Bond Index TRS to express views on European sovereigns, while a superannuation fund used the Barclays Inflation Index TRS for replicating its global inflation portfolio returns. "This is likely to be a growing trend because, compared to nominal bonds, inflation bonds are a better buy. And accessing these bonds through total return swaps is likely to be a rising trend," says Agarwal.

Total return swaps on the indexes also allow clients to adjust exposure to specific sectors in their portfolios without having to sell the physical bonds, according to the bank.

Barclays has also developed and launched the Level Pay Notes. "We identified a need in the market for a product that provides a steady source of income via predefined payments and provides a good return on savings, as well as taking care of regular anticipated outflows," says Agarwal.

Unlike a standard bond that pays periodic interest and returns 100% of principal at maturity, the Level Pay Notes make monthly payments that consist of both interest and a partial return of principal. This enables them to be used as a tool for managing cash flow or as part of an investment or retirement portfolio, according to the bank. "Level Pay Notes are structured a little like a mortgage, but in reverse, so the investor deposits a sum of money and gets it returned in equal payments," says Agarwal. "You would have a stream of payments rather than a principal payment at the back."

The monthly payments can also be protected against rises in inflation. In this case, the payments would consist of both inflation-adjusted interest and a partial return of inflation-adjusted principal, which is calculated through scaling the payments via a consumer price index ratio. The notes were first sold in Asia in December 2011 and insurance companies are the primary clients, with trades so far in the tens of millions of dollars.

Providing liquidity and secondary markets through repackaging vehicles has also been a priority for Barclays over the past year. "The repack concept is fairly new to investors, but it is becoming an increasingly popular choice," says Agarwal. For example, a US-based investor wanted to sell a structured note with a US dollar inflation payout issued by an Australian issuer, arranged by another dealer.

Barclays used its repackaging vehicle to issue a note collateralised by this inflation note, with cash flows asset swapped into fixed yen, thereby allowing clients in Japan to buy these notes (as they were unable to execute asset swaps as part of their mandate).

"This is an example of being able to connect the dots between buyers and sellers... it was the first time we did this in Asia using an inflation-linked bond and selling an underlying asset denominated in one currency," he says.