Svensk's notes linked to two indexes offer good terms, timing despite leveraged downside

By Emma Trincal

New York, Aug. 23 - AB Svensk Exportkredit's upcoming 0% buffered notes linked to a basket of two indexes offer attractive terms and opportune timing amid the sell-off, but the leverage applied to the downside may put off some investors, sources said.

"This is not a bad deal," said Lee Kramer, president of Capital Management Analytics.

"But what I don't like is the leverage on the downside, particularly because a lot could happen in three years."

The notes are expected to mature 36 to 42 months after the issue date, according to a 424B2 filing with the Securities and Exchange Commission.

The basket is comprised of the MSCI AC World index with a 70% weight and the S&P 500 index with a 30% weight.

The MSCI AC World index is a global stock index covering the equity market indexes of 45 countries, representing 24 developed and 21 emerging market countries.

Downside leverage

If the basket return is positive, the payout at maturity will be par plus the basket return, up to a maximum payment of $1,282.50 to $1,330.00 per $1,000 note.

Investors will receive par if the basket declines by up to 25% and will lose 1.3333% for every 1% that it declines beyond 25%.

"So assuming that we have a terrible market and that the basket ends up down 50%, you lose a third of your principal. It's still better than losing half, and this is a low-probability event, but you still have that risk," Kramer said.

"Clients may not like the deal just because of that. The idea that your losses are magnified after you go below the buffer makes it a little bit less appealing."

A market participant agreed.

"It's not the most attractive deal I've seen in the past few weeks," he said.

As stated in the prospectus, investors in the notes could lose their entire investment while their participation to the upside is limited by the cap.

"There is more risk to the downside," the market participant said.

"You have no leverage on the upside but leverage on the downside past the buffer."

For this market participant, the relatively less attractive terms may have to do with the use by the underwriter, Goldman Sachs & Co., of a third-party issuer.

"It's issued by [Svensk] Exportkredit via Goldman Sachs, and it could be that you have a little bit more expenses because you're using somebody else's balance sheet," he said.

"It would be useful for someone mildly bullish on the market who would want to upgrade the credit risk and have no exposure to Goldman. But that's not our case."

Tenor and dividends

The duration of the product, according to Kramer, is also a drawback.

"Three years is a little bit long for my taste. We know that interest rates will be low for the next two years, but we don't know after that," he said.

He pointed to the dividend yield of the S&P 500 index - "a little bit less than 2% - and to the yield of the MSCI AC World index -"a little over 2%."

"You're giving up approximately 2%," he said. "Three years is a quite an amount of time for foregoing 2% in dividends per year.

"Normally it's not a big deal, but with interest rates so low, you're giving up a lot."

Buffer and cap

However, several other factors offset some of the negative features, making the deal attractive overall, said Kramer.

The first positive feature is the 25% buffer.

"The buffer seems reasonable to me," said Kramer.

"Between the fall of Lehman Brothers in September 2008 and March 2009, the 800 level for the S&P 500 was a key support level."

Support, a term used in technical analysis, designates a level below which it is supposedly difficult for a security or market to fall.

"A 25% drop from where the S&P 500 is today would take us a little over 850, above the 800 support level.

"It's a reasonable protection for a three and a half year. We could revisit the lows of Lehman Brothers at the end of 2008 and yet be protected by this buffer," he said.

Secondly, Kramer said that the cap is "decent" at about 30%, or 10% per year.

"It's decent particularly in this low-rates environment," he said.

U.S. overweight

The underlying basket represents a mix consisting of 70% in global stocks and 30% in the S&P 500. But Kramer noted that U.S. stocks have a 43% weight in the MSCI AC World index.

"So overall you're talking about a 40% exposure to international stocks and a 60% exposure to domestic stocks," he said.

"I think this represents a good balance for the average U.S. investor.

"This asset mix is pretty much in line with what a lot of portfolio managers are doing, especially given that many U.S. corporations earn half or more of their profits from overseas.

"Personally, the 60% allocation to U.S. equity is fine with me as U.S. stocks have good prospects and valuations are very attractive."

Entry point

Finally, the deal comes amid a market correction, which is also a positive for the investor, Kramer noted.

"The timing for this may be good," he said.

"We just had a quick downdraft in the market, both internationally and in the U.S., with a drop of almost 20% for the S&P 500.

"In this low-interest-rates environment and with those low valuations, I think the timing is right," he said.

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