Deutsche Bank's notes tied to currency basket make leveraged, unprotected bet against dollar

By Emma Trincal

New York, Oct. 26 - Deutsche Bank AG, London Branch's upcoming leveraged notes tied to four Asian currencies against the U.S. dollar are designed to capture the benefits of a very popular macroeconomic theme amid a tepid supply of currency-linked notes expressing this view, sources said.

But the lack of downside protection and the asymmetrical leverage led some to caution against the speculative aspect of the trade as well as the risk embedded in the structure.

Deutsche Bank plans to price 0% return enhanced notes due May 3, 2012 linked to the performance of a basket of currencies relative to the U.S. dollar, according to an FWP filing with the Securities and Exchange Commission.

The basket includes equal weights of the Indian rupee, Indonesian rupiah, Korean won and Singapore dollar.

The payout at maturity will be par plus at least 4.1 times any appreciation of the basket relative to the U.S. dollar, subject to a maximum return of at least 20.5%. If the basket depreciates relative to the U.S. dollar, investors will be exposed to the decline.

Bulls on global growth

"If you believe emerging-markets countries have a strong economic outlook going forward, I would see why this product makes sense," said Win Thin, senior currency strategist at Brown Brothers Harriman & Co.

"We are bullish on Asian currencies going up a year, a year and a half, so this would fit our view. It's a play on global growth, or on exports in emerging markets, not so much on higher interest rates."

Thin said that some of the countries represented in the basket, such as Indonesia, have high interest rates, which makes them eligible as "buys" as part of a carry-trade strategy. But other countries, such as Korea and Singapore, show much lower rates, he noted, with Korea's overnight rate similar to the U.S. level.

"This is mainly a bet on global growth," he said. "The high-yield theme is only secondary."

A market participant who specializes in currencies said, "I agree with the underlying view. I think these currencies have a good chance to appreciate against the dollar within the 18 months timeframe."

Asymmetrical structure

Yet he said, "In my opinion, the structure is not appropriate for retail investors.

"I like the underlying bet, but it's still a very risky bet as we can get a global crisis within that timeframe as well.

"Everybody is shorting the dollar against emerging-market currencies right now. There's plenty of leverage out there. If we enter a global economic crisis, people will cover their shorts, selling their positions in emerging-market stocks, emerging-market currencies, and the dollar will surge as a result.

"Unless you hedge those notes, you're taking a very speculative bet.

"In addition, the risk/return profile is asymmetrical because your return is capped and you don't have downside protection.

"You have to be a sophisticated investor who understands leverage to use that type of instrument."

Fills a need, gap

Eric Greschner, portfolio manager at Regatta Research & Money Management, said, "I don't think it matters whether you're a retail investor or not. What's important is your level of sophistication and what you're trying to accomplish.

"We've received a lot of phone calls from clients concerned about a continued depreciation of the dollar and looking for ways to diversify their portfolios."

He said those clients are not just U.S.-based investors. In several cases, they are also U.S. citizens who live abroad and who see their dollar holdings shrinking with the decline of the U.S. currency, he noted.

As a portfolio manager, Greschner put some of his clients in some vehicles, such as exchange-traded notes and mutual funds, that seek to profit from an appreciation of Asian currencies versus the dollar.

He cited Barclays Bank plc's GEMS Asia 8 ETN, an ETN that benefits from the appreciation of eight Asian currencies, and the Merk Asian Currency Fund, which is also a product that offers positive returns when Asian currencies rise against the dollar.

"There's not a ton of vehicles out there that give you that type of exposure. And none of these instruments offer downside protection," he said.

Hedge it

"Depending on the sophistication of the client, on the size of the portfolio and whether the product can be used in addition to other tools such as ETFs or closed-end funds, I think this product can be appropriate," Greschner said.

"We would set up clients with options accounts so that if the basket depreciates by a certain percentage, say 10% or 20%, they can offset that with an option. They can short the basket.

"If you're a sophisticated investor, and if you're willing to ride through it, if you have the ability to hedge it, it's not a bad investment."

The notes (Cusip 2515A1AV3) are expected to price Oct. 29 and settle Nov. 3.

JPMorgan Chase Bank, NA and J.P. Morgan Securities LLC are the agents.

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