Credit Suisse’s five-year accelerated barrier notes linked to EM ETF offer long-term bull play

By Emma Trincal

New York, Jan. 29 – Credit Suisse AG, London Branch plans to price 0% accelerated barrier notes due Feb. 2, 2024 linked to the iShares MSCI Emerging Markets exchange-traded fund, according to a 424B2 filing with the Securities and Exchange Commission.

If the ETF finishes at or above its initial level, the payout at maturity will be par plus 125% of the ETF return, capped at par plus 94.2%.

If the ETF falls by up to 40%, the payout will be par.

Otherwise, investors will be fully exposed to the ETF decline.

“It’s not a bad trade. The thing that helps the most is the five-year [term],” said an equity trader.

“Between Brexit, the Mexican wall, China, it’s going to take a while for this stuff to be resolved and to filter through the emerging economies.”

He looked at a five-year chart of the ETF and said the notes were reasonably priced.

“The 1.25x is going to work for you,” he said.

Having the leveraged return on the upside but not on the downside was a contrast with leveraged ETFs and an advantage, he added.

This trader said he is relatively bullish on emerging markets.

The lowest point on the chart was in January 2016 when the ETF share price closed at $27.61. The price then hit a five-year high two years later at $52.08. Since then, the price hit support in October at $38.00.

“We tested it again a month later and we bounced off of that point. We’re now at $41.83. It looks like we’re moving higher,” he said.

The uptrend was still not confirmed.

“We’re not quite on a reversal yet because it hasn’t moved high enough. But it has the potential.”

Emerging markets have a negative correlation with the dollar. This trader pointed to the impact of the Federal Reserve’s policy on the dollar and by extension on the underlying.

“They’ve been raising rates and shrinking the Fed’s balance sheet. That was bullish for the dollar. Now that the Fed has recently signaled that they’re going to be patient, emerging markets have started to move up again.

“The dollar has come off its highs, and it’s been kind of moving sideways. Emerging markets have bounced back.”

Terms

The question of how easily the underlying fund could outperform the cap was anyone’s guess. But based on the chart, he saw a contained risk of missed upside.

“Your biggest move on the upside was a 90% increase from January 2016 to January 2018. On the downside, the worst for the period was between the January 2018 high and the October low, a 27% drop,” he said.

“And these are the biggest moves in the last five years.

“You haven’t hit the cap during that time; you haven’t breached the 40% level on the downside.

“We’re now in an uptrend. A lot can happen in five years. But it looks constructive.”

Exotic at best

Scott Rothbort, founder of LakeView Asset Management and professor of finance at Seton Hall University, was more skeptical.

“I wouldn’t use it for my portfolio. If I can’t explain something to my clients, I tend to stay away from it. If you’re a sophisticated investor, a hedge fund for instance, you can replicate this yourself with options,” he said.

But the replication would require some expertise, he conceded.

For instance, listed options would not permit investors to duplicate the five-year maturity. Even the so-called LEAPS (Long Term Equity Anticipation Securities), which are the longest listed options contracts, would extend only to a two-year term.

Issuers of structured products create and hedge the product with options that trade over the counter.

They also use more complex options, which differ from traditional puts and calls.

For instance, the replication of the 60% barrier would require the use of exotic options. The mere sale of an out-of-the-money put at a 60% strike would bear a closer resemblance to a buffer as the first 40% of decline would be protected, which is not the case with the barrier when the price declines by more than 40%.

Secondary market

More fundamentally, Rothbort said he was not comfortable with the liquidity of the notes.

“The liquidity is very small. You only have one buyer. That’s a problem,” he said.

He was referring to common characteristics of structured notes in general, explicitly disclosed in the prospectus: the notes do not trade on a security exchange, the issuer is not required to buy back the products even if it intends to do so, and a secondary market, if there is one, may not provide enough liquidity.

This registered investment adviser said there are alternative ways to get an exposure to international markets.

“If you really want the broad exposure to emerging markets, why can’t you just buy the ETF directly?” he said.

Think big

For investors with his own style who like to carefully pick the stocks of the companies they know and like, a portfolio of large caps could provide a good alternative as well.

“People forget that they can get international equity exposure when investing in U.S. companies. Each time you invest in the stocks of multinationals, you get immediate exposure to Europe or Asia and the Pacific region, the Middle East, Africa. Take IBM for instance. Only 50% of their revenues come from the Americas.”

He mentioned the example of Apple’s market share in China.

Pharmaceutical company Pfizer generates 20% of its revenues from emerging markets, he added.

“You already have emerging markets exposure in your portfolio because you own multinational companies that are doing business there. People tend to believe that if you own U.S. companies, you only have exposure to the U.S. You may have exposure to the U.S. stock market but not necessarily to the U.S. only as a country.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on Jan. 30.

The Cusip number is 22551LUT5.

© 2015 Prospect News.
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