Credit Suisse, HSBC show leveraged capped notes designed for conservative investors

By Emma Trincal

New York, May 24 – The supply of leveraged notes has been shrinking this year as autocallables have become the predominant structure in the market. Yet there is demand for barrier or buffered enhanced return notes especially in a market scoring frequent all-time highs, which rationalize the existence of a cap.

Advisers examined two recent leveraged capped notes offerings, expressing different viewpoints.

Two deals

The first one, Credit Suisse AG, London Branch’s $427,000 notes due June 23, 2022, offers a short tenor with the exposure to a single asset – the S&P 500 index. The issuer was able to price two-times leveraged exposure on the upside with a 10% buffer on the downside despite the 13-month maturity.

The cap however is limited to 10%, which represents a 9.23% annualized compounded return.

The other, brought to market by HSBC USA Inc., settled earlier this month at a $3.47 million size.

The 0% barrier capped leveraged notes due May 5, 2023 are tied to the worst of the Dow Jones industrial average and the Nasdaq-100 index.

Both cap and leverage multiple are higher at 26.5% and 3x, respectively.

On a compounded basis, investors can make up to 12.47% per year.

The 20% protection is twice as much in size but is offered as a barrier, not a buffer.

Not upbeat

“There are similarities in those two products. The view is a neutral or pessimistic one,” said Steven Foldes, vice-chairman of Evensky & Katz / Foldes Financial Wealth Management.

“For investors who are conservative and who have that type of outlook, both notes are appropriate.

“The first one is very short-term, which is fine. You only get 10% on the upside with a 10% buffer. Even though you get the leverage, you have to have very low expectations about the market,” he said.

Investors in the notes will reach the maximum return if the index grows by 4.62% a year.

“You’re not anticipating a significant level of appreciation,” he said.

For the second note, Foldes focused on the two underlying indexes.

“The Nasdaq outperformed the Dow by a long shot last year and to a certain degree, in 2019 too.

“I’d much rather have exposure to the S&P and the Dow than to the Dow and the Nasdaq.

“The 26.5% cap is better. But you still have low expectations by virtue of the 3x exposure,” he said.

The annualized index growth required to reach the cap would only be 4.32%.

Making it better

When comparing the two notes, Foldes said that he was inclined to prefer the second one. While the short tenor and single asset exposure of the first one was attractive, he would opt for the worst-of structure, which can provide better terms.

“Again, both notes are quite conservative. You have to have a pretty negative mindset. But I would probably go with the worst-of for its higher cap,” he said.

However, Foldes would have to “restructure” the HSBC notes to make the product work for him.

First, there should be more similarity between the two underlying indexes, he said, reiterating his preference for the pair consisting of the S&P 500 index and the Dow Jones industrial average.

Second, the barrier would have to be replaced by a buffer.

“A 20% barrier is nice. But it’s possible that over two years, one of those two indices, especially the Nasdaq, could go down by more than 20%. I prefer a buffer. A buffer is a hard lock.

“The buffer would probably have to be less than 20%. Maybe the leverage would have to be lower as well or maybe the cap. These are things the issuer would have to calculate based on the options price,” he said.

The case for leverage

Overall, both notes make sense in general, but especially so for defensive investors.

“The market has been hitting new highs. The idea of having leverage on the upside and some downside protection where it be a barrier or a buffer is nice even if it’s capped,” he said.

“But none of the two notes are a good fit for optimistic investors. You have to be neutral to negative about what the market will do in order to be considering those offerings.”

Buffer

Carl Kunhardt, wealth adviser at Quest Capital Management, had a strong preference for the buffered note tied to a single index.

“From my perspective, the first one offers a better match. My average client is approaching retirement or is already retired. For those, stability is important,” he said.

“13 months over two years: huge difference. I prefer the shorter timeframe.

Kunhardt said he favors buffers over barriers.

“Unless there is a silly difference, like a 60% barrier versus a 10% buffer, I’m for the buffer. Here the 10% difference between the two doesn’t cut it,” he said.

One underlier

Another important difference was the single-asset exposure of the first offering versus the worst-of payout of the second one.

“I never liked worst-of. I like a note sticking to one index.”

Finally, Kunhardt said he is “not a fan” of the Dow Jones industrial average.

“It’s only 30 stocks. That’s not what I call a diversified index. It’s price-weighted, unlike the S&P, which is cap-weighted. A price-weighted index is not representative of what the market is actually doing. And who picks the stocks? A bunch of journalists. I’m not crazy about that either.”

The index committee selecting the Dow’s components is composed of three representatives of S&P Dow Jones Indices and two editors of the Wall Street Journal.

Plain and simple

The buffered notes were much more attractive, according to this adviser.

“No worst-of. It gives investors more confidence.

“Two times up to a 10% cap. Now: is 10% too low? Since my forecasting assumption for the S&P is 6.5% to 7% a year, sounds good to me. You’re giving me 10%. I’m pretty much done,” he said.

The short tenor was also a plus.

“Waiting for 13 months is not a big deal. I’m not going to do any rebalancing during that time except for tax harvesting unless something goes bonkers like last year,” he said.

The simplicity of the structure was perhaps one of the most appealing aspects of the deal.

“The make it or break it is how easy it is to explain to a client. This one is very easy.

“The only thing I ask for an investment is that it behave like I expect it to behave, up or down. I’m not expecting the market to go one way or the other. But the product should be easy to understand, easy to monitor, easy to evaluate. This one makes the cut,” he said.

For the Credit Suisse deal, the agent is Credit Suisse Securities (USA) LLC.

The notes (Cusip: 22552XLW1) priced on May 19 and settled on Monday.

The fee is 0%.

HSBC Securities (USA) Inc. is the agent for the HSBC offering.

The notes (Cusip: 40438C4K4) settled on May 5.

The fee is 0%.

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