Credit Suisse's absolute return barrier notes tied to MSCI EM offer hedge, range bound play

By Emma Trincal

New York, Nov. 15 - Credit Suisse AG, Nassau Branch's 0% absolute return barrier notes due May 30, 2014 linked to the iShares MSCI Emerging Markets index fund offer enough of a range to satisfy a variety of views from bearish to mildly bullish and could be employed for hedges and even for directional plays, sources said.

A barrier event will occur if the exchange-traded fund's shares close below the barrier level on any day during the life of the notes, according to a 424B2 filing with the Securities and Exchange Commission.

The barrier level is expected to be 69% to 72% of the initial share price and will be set at pricing.

If the final share price is greater than the initial share price, the payout at maturity will be par plus the ETF return, subject to a maximum return of 17%.

If the final share price is less than the initial share price and a barrier event has not occurred, the payout will be par plus the absolute value of the ETF return, subject to a maximum return of between 27.99% and 30.99%.

If the final share price is less than the initial share price and a barrier event has occurred, investors will be fully exposed to the decline from the initial share price.

The exact caps will be set at pricing.

Bear bias

"I see it as more of a bear note because you can get more return out of this note if the market is down than if it's up. Your potential return on the bear direction is 28% while your upside is limited to 17%," said Steve Doucette, financial adviser at Proctor Financial who hypothetically picked the more conservative barrier level of 72%, or a 28% contingent protection.

"It could also work for somebody having a range bound view, hoping the market won't be up by more than 17% otherwise you underperform the ETF and not down by more than 28%, otherwise this note is worthless," he added.

While the 28% soft barrier seems attractive on the surface, only the underlying volatility of the ETF can determine if it is adequate, he said.

"The average bear market decline has been 35% since World War II," he said.

"But that's for the U.S. markets. The emerging markets average decline could be uglier.

"You get exposure to emerging markets but it's all driven by volatility. How volatile this market is going to be, that's a call the investor needs to make."

And it's not an easy one to make, he noted, especially at a time when developed countries are seeing their markets turning more volatile under the double pressure of the ongoing European crisis and the looming fiscal cliff in the United States.

"Emerging markets, China need the U.S. and Europe for growth. If we're not doing well, the question is whether they can do well on their own," he said.

Downside

"You could also consider this structured note as a hedge. It's nothing more than a hedge when you think about it. A bear note would be a directional play on the downside. With this, you can make the same bet and benefit even if you're wrong as long as you stay in the range."

From a structure standpoint, Doucette said that he saw two drawbacks in the product.

"I'd hate to cap my upside. But we know we need some protection. It's always difficult to decide how much upside you're willing to give up for that," he said.

More importantly, Doucette said that he was not comfortable with the "American barrier," or the "any day" observation frequency, for the barrier event during the life of the notes, as opposed to a so-called European barrier, which monitors the barrier event only at the end of the term.

"I just don't like these American barriers but I can see it does offer some benefits in return such as higher cap or a better protection.

"And yet, I hate the concept of it. You have the panic sell-off and you can easily burst that barrier," he said.

Growth potential

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said that the notes offered bullish investors a comfortable level of downside protection, enabling them to score a gain even if they were wrong providing that the barrier was not breached.

"Emerging markets are very coupled with the U.S. and the broader markets. However, we see great opportunities in emerging markets within the next 18 months. Eighteen months is a good timeframe because I do think the next six months could be a challenge," Medeiros said.

"I also like the absolute return feature. It's fantastic. If you think what happened this year, you bought at the peak in the market and it would close today, you would be down 15%...To have an inverse that gives you a 15% positive return is a huge bonus," he said.

The entry for the trade may be favorable as well, he noted.

"Now emerging markets are trading at their later part of January levels. All the growth through April, May is pretty much gone. The asset class itself is trading at a good value relative to its historical PE. Over the next 18-month, there are good growth opportunities in this asset class.

The range between the downside barrier and the upside cap was wide enough to provide investors with flexibility, he said.

"To get a 28% downside protection and be capped at 17% on the upside seems like a fair view for emerging markets," he said.

"The delta between a 28% negative and a 17% gain is very advantageous for the asset class."

BNP twin win

A similar product was recently announced using the same underlying.

BNP Paribas said it plans to price 0% capped twin win notes due Nov. 26, 2014 linked to the iShares MSCI Emerging Markets index fund, according to a term sheet.

The structure has similar terms except for the tenor of two-year instead of 18-month.

The knock-out level is expected to be 70% of the initial share price and is observable any day as well.

The payout conditions are the same but an important difference is the upside as it offers leverage unlike the other note. The annual cap can also be slightly higher depending on the selected level at pricing.

If the final share price is greater than or equal to the initial price, the payout at maturity will be par plus 150% of any gain in the price, subject to a maximum return of 22% to 24%.

"I don't know if I would prefer the two-year," said Medeiros, comparing the two products.

"The return is not going to be that dissimilar. Yes there is the leverage factor. But the difference in the terms would not motivate me to go through an extra six months."

Doucette had a different view.

"This could give you a higher cap or just a little bit less at a fractional level," said Doucette, who noted that Credit Suisse offered an 11.33% annualized cap while the BNP annualized maximum return, comprised between 11% and 12% had the potential to be slightly lower and also higher.

"On the downside, you have about the same 30% threshold," he said.

"You get the same kind of metrics but the BNP deal gives you the leverage. The real difference is the two-year term for the BNP versus 18-month with the Credit Suisse.

"Personally, I would choose the two-year just to get the leverage and possibly a better cap. If things get resolved and turn around, I don't want to give up on the upside.

The BNP view is a little bit more optimistic I would say."

The Credit Suisse notes (Cusip: 22546TK59) will price Nov. 28 and settle Nov. 30.

Credit Suisse Securities (USA) LLC is the agent.

The BNP notes are expected to price Nov. 20 and settle Nov. 26.

BNP Paribas Securities is the agent. The distributor is Advisors Asset Management, Inc.

The Cusip number is 05574LCJ5.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.