Credit Suisse’s allocation securities on weighted basket to mitigate risk, enhance returns

By Emma Trincal

New York, April 26 – Credit Suisse AG, London Branch’s 0% allocation securities due April 30, 2024 linked to a basket of the S&P 500 index, the MSCI EAFE index and the MSCI Emerging Markets index offer the opposite of a “worst-of” by allowing investors to capture the best return of three equity indexes. Sources applauded the concept of a “best-of” used in the structure, as it gives the best performing index the most heavy weight.

The best performing of the indexes will be given a 95% to 100% weight, the index with the second-best performance will be weighted at 0% to 5% and the lowest-performing index will not count toward the basket performance, according to a 424B2 filing with the Securities and Exchange Commission.

At maturity, investors will receive a return based on par of $10 multiplied by the allocated basket return.

“This is very different than the typical deal on one index. We’re not talking buffer or barrier. We’re talking about optimizing the allocation,” said Steve Doucette, financial adviser at Proctor Financial.

“We’ve done a similar deal recently. We liked it a lot. It’s a true best-of. They ended up pricing it at 100%, not 95%, which is great.”

For Doucette, this structure was just as much about enhancing returns as it was about protecting against downside risk.

No need for a buffer

“We discussed the issue of protection. This note doesn’t come with a buffer. So what’s the best thing to have: a buffer or that type of allocator? We found that having the 100% allocation to the best index was much better actually.

“By definition putting everything in the best asset class makes you less likely to lose money.”

All three indexes however could finish negative, which would generate a loss despite the weighted payout.

But Doucette said that the longer duration added another layer of protection.

“If you go out five years, you’ll see a pullback. But the market will go back up before that. I guess this is my personal bias. So I’m not so worried about a buffer over a five-year term,” he said.

This adviser said his firm looked into adding a buffer, just for the purpose of getting an idea of pricing.

“It didn’t make sense. As soon as you do that, the weights change and you no longer get 100% on the best-of. It becomes 60%, 30% and 10%. Introduce a buffer and it changes the whole deal.”

“It was just not worth it because it reduced the best part of the allocation – the 100% that goes to the best-of.”

Bold weights

A market participant said he saw similar structures before but that they are far from common. The weighting given to the best asset as high potentially as 100% was also impressive.

“It’s pretty interesting and it’s different from the rainbow 70%-30%. This one with 100% is pretty bold,” he said.

“What’s interesting is that those three indices are not very correlated. If they were, you wouldn’t benefit as much from the structure.”

A rainbow is an option that pays either the best or the worst performance of one or several underlying assets.

Best-of notes give investors more chances to obtain higher returns when the underlying assets have low or negative correlations. It is the opposite with worst-of, for which low or negative correlations imply higher risk, he explained.

Asked whether the optimal allocation could mitigate the downside risk as well as a buffer, this market participant said that it was hard to tell.

“I wouldn’t say it’s like having a 20% buffer. Maybe it’s like having a 10% or a 5% buffer. You’d have to price it,” he said.

“But what’s attractive is that even though you don’t know what’s going to happen in five years, you’re getting the best as opposed to the worst.

“It’s also better than an equally weighted basket since you apply the full weight of the best performer.

“It looks like a pretty good deal for somebody who wants to get exposure to these markets.”

Contrarian tilt

Another advantage to the structure was that it enabled an investor to make a value bet with less risk.

“I like this deal because I believe in mean reversal. Emerging markets and the EAFE haven’t done so well compared to the U.S. They should outperform. But you don’t know by how much and you don’t know how long it will take.

“I’m bullish on emerging markets, but it’s a volatile asset class. This note captures the emerging markets performance without taking the downside risk,” he said.

The low correlation between the underliers could support more contrarian plays.

“Two of those three indices have severely underperformed the S&P, the emerging markets one especially. They’re going to do something different next. Either they will catch up or they will fall less than the S&P.”

He concluded that the “rainbow” structure could be integrated in a value strategy especially over the five-year timeframe.

“Your premise is to go where value is,” he said.

“It’s a great way to capitalize on asset class valuations. We know that emerging markets is probably the best value purchase out there. The EAFE is somewhere in the middle. Those allocations and the designated asset classes work well in this best-of.”

UBS Financial Services Inc. is the distributor.

The notes settle on April 30.

The Cusip number is 22550F187.

© 2015 Prospect News.
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