Credit Suisse notes tied to iShares MSCI EM offer low entry, defensive absolute return feature

By Emma Trincal

New York, June 27 - Credit Suisse AG, London Branch's 0% absolute return barrier securities due Jan. 4, 2016 linked to the iShares MSCI Emerging Markets index fund offer a defensive and appealing component with the absolute return on the downside, sources said.

But the underlying fund has already been underperforming the market, which makes the feature less relevant for some, more attractive for others, depending on one's assessment of the risks associated with emerging markets.

The payout at maturity will be par plus 1.5 times any gain in the fund, up to a maximum return of 33%, according to a 424B2 filing with the Securities and Exchange Commission.

If the shares finish below the initial price but above a 75% knock-in level, the payout will be par plus the absolute value of the return, up to a cap of 25%.

If the shares finish below the knock-in level, investors will be fully exposed to the decline.

The exact leverage factor, cap and knock-in level will be set at pricing.

Investors must give up the 1.75% annual dividend yield and accept the cap, which at 33% is about the equivalent of 13% a year, if they want to benefit from the 150% upside participation rate, the 75% barrier and the absolute return feature for any fund decline of less than 25%, according to the prospectus.

Sideways

But with the fund down 14% year to date, compared with the 13.5% gain recorded by the S&P 500 index, some questioned whether the upside cap was elevated enough as the entry point already reduces some of the risk. Steve Doucette, financial adviser at Proctor Financial, said that he would rather see less downside protection but a higher cap.

The notes are designed for a narrow range, he said.

"You have to believe this index will close between minus 25% and plus 22% at the end of the term," he said, taking into account the 1.5 times leverage factor on the upside, which brings the 22% gain to the 33% cap.

"If you stay within this range, you'll outperform the fund.

"But emerging markets have been underperforming. It's been flat in the past two-and-a-half years while the S&P was up 28%. And now you're capped at 33%?

"You really have to believe that there won't be any rebound in the emerging market space.

"I tend to be a little bit contrarian. Historically, you have growth when an asset class comes from the bottom of the pack and moves up to the top."

However, given how volatile the asset class can be, Doucette said that the absolute return feature remained a positive side of the deal.

Rebound scenario

"If you're looking for exposure to emerging markets, it's neat to get the absolute return component because volatility gives you favorable terms," he said.

"Volatility is pretty high for emerging markets, and by selling it you're able to get the leverage plus more protection."

However, investors should take into account current market prices, he noted.

"You're starting already down 14% for the year. To breach the barrier, you would have to go down an additional 25% from that point. The question is - and I don't have the answer to it - what's the likelihood this market will go down 40% at this point?" he said.

"Because it's underperforming, I would rearrange the terms. I would give up a little bit of the barrier - go for instance to 80% instead of 75% - in order to get a higher cap and perhaps more leverage, or one or the other. I would have to look at these combinations.

"The emerging markets economies are still growing faster than the U.S. economy, and that should be reflected in their market price going forward. As of now, this index shows a huge underperformance level. No one knows where it's heading to, but I would probably want to increase the upside."

Headwinds

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said that current valuations were compelling from a value standpoint. However, given that emerging markets are still facing headwinds, the absolute return feature remained appealing.

"From an asset class perspective, I like the fact that it has pulled back so much. It's down substantially this year. That in itself offers a potential entry point for someone who wants exposure to emerging markets," Medeiros said.

"However, the emerging markets space is going to be challenged if the global economic growth doesn't pick up.

"The current valuation makes the entry point compelling. But the structure makes it a lot more interesting. If emerging markets go down 10%, you're still making money.

"I like the absolute return here because many challenges remain in this space. A sluggish global growth, currency pressures and price compression on commodities lead me to say that emerging markets continue to struggle, so it's a good thing to be able to capture a gain out of the index decline, up to a point.

"My concern in a normal market would be to have the cap too low. However, in this case, I think we have enough room for a move on the upside if we see a rebound. At the same time, the absolute return feature takes care of the potential market downturn."

Credit Suisse Securities (USA) LLC is the agent.

The notes were expected to price Thursday and will settle Tuesday.

The Cusip number is 22547Q5F9.

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