Credit Suisse’s CS notes linked to CS Retiree Consumer index target risk-averse investors

By Emma Trincal

New York, May 3 – Credit Suisse AG, Nassau Branch’s 0% CS notes due May 27, 2021 linked to the CS Retiree Consumer Expenditure 5% Blended Index Excess Return may appeal to the cautious investor for the principal protection and the low volatility target of the underlying index, sources said.

The payout at maturity will be par plus 145% to 155% of any index gain, with the exact participation rate to be set at pricing, according to a 424B2 filing with the Securities and Exchange.

If the index falls, the payout will be par.

Smart beta

The underlying index is a rules-based index designed to mirror the consumer expenditure patterns of U.S. retirees, according to the prospectus. It maintains a low annualized volatility target of 5%. The index is rebalanced each year.

The data is extracted from the Consumer Expenditure Survey published by the U.S. Department of Labor. The rules assign category weights to sectors based on the percentage of consumer expenditure for the age group classified as 65 years and older.

The current seven sectors used in the base index are real estate, transportation, food & beverage, health care, consumer discretionary, apparel retail and insurance.

“I’ve never seen this index before. ... Interesting,” said Donald McCoy, financial adviser with Planners Financial Services.

Low volatility

The main goal of the underlying index is to offer market exposure with less risk, he said.

“These are probably sectors that suffer less in a market downturn,” he noted.

“It looks that we have consumer staples that are more resilient. That could be one of the reasons they’re targeting those sectors.”

McCoy said he does not believe the index was designed as a marketing ploy for retirees.

“I don’t think they’re doing that based on demographics. I just think these are stocks and sectors that are less volatile. If you want market exposure and expect to achieve close to if not better returns than the market with a lot less risk, that may be the way to do that,” he said.

The index showed a 1.4% loss on a one-year annualized basis versus a negative return of 1.6% for the S&P 500 index from Feb. 27, 2015 to Aug. 31, 2015, according to the prospectus. The index was established on Feb. 27, 2015.

The hypothetical three-year return was 4.7%, compared with 11.9% for the S&P 500. Over a 10-year period, the CS index and the S&P 500 showed annualized returns of 3.9% and 4.9%, respectively.

Dividends

The structure of the index could appeal to a broad group of investors seeking risk mitigation.

While the leverage is attractive, it is not the main feature of the deal, he said.

“You don’t get the dividends. Over a five-year cycle, these areas probably offer high dividend payments. So I suppose the leverage is kind of what you need to make up for the loss of dividends. It may not give you back all of it but some.”

The absence of a cap combined with the full downside protection may be appropriate for the current market environment, he added.

Fully protected

“If you are in a low return environment, like I kind of think we are, dividends are going to be a big part of your total return. The leverage is sort of necessary here in that way, especially if they’re stripping off the dividends during a five-year period,” he said.

“What you’re really getting is the principal protection, and that may be the biggest selling point.”

Many investors, including some of his clients, feel uncomfortable investing in the market at this point as they fear they may be buying at the top, he explained.

“If we’re in a flat, sideways market, this may be the way to give people exposure to equities while making them comfortable enough to take that step.”

Risk mitigation

A potential client, he said, may reason as follows: “Yes, I’m getting into a fully valued market, I’m giving up the dividends, but at the same time, I invest in less-volatile stocks with highs and lows that tend to be more moderate. Most important, I get to keep my money.”

Risk-averse investors would be the typical buyers of the product.

“This is for people who don’t have that much confidence in the market. I can think of a couple of conservative clients who are feeling antsy that would probably look at this favorably.”

Theme-based

Tom Balcom, founder of 1650 Wealth Management, said the underlying index itself is an important part of the product.

“There is a story here. You’re selling to retirees companies that they are familiar with, things that they buy. It’s the ‘know-what-you-own’ concept,” he said.

Smart beta indexes are not always easy to explain, he added, but probably would be in this case.

“If they recognize the name, if it’s not a bunch of esoteric companies, they’ll look into it.”

Structure, taxes

The structure offers attractive features too.

“You’re getting no cap, and you’re getting 1.5 times leverage. Having those two things with full protection makes the notes quite interesting.”

One “issue,” he said, is the taxation of the notes.

As buyers of a principal-protected instrument, investors must pay ordinary income taxes each year on earnings they only receive at maturity. The so-called “phantom income,” which is a negative aspect of investing in a bond sold at a discount, is usually unpopular, especially with investors in high tax brackets, he said.

“Right now though, it’s modest because rates are so low,” he said.

“I don’t think it would be such a big deal.

“This note is pretty interesting. I’ll definitely look into it.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on May 20.

The Cusip number is 22548Q5R2.

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