Credit Suisse’s absolute return notes linked to S&P 500 to offer alternative to long position

By Emma Trincal

New York, April 27 – Credit Suisse AG’s 0% absolute return barrier securities due May 27, 2021 linked to the S&P 500 index may offer an attractive risk-adjusted return for buy-and-hold investors, some financial advisers said.

A knock-in event will occur if the final index level is less than or equal to the knock-in level, 70% of the initial level, according to a 424B2 filing with the Securities and Exchange Commission.

If the final index level is greater than or equal to the initial index level, the payout at maturity will be par plus 115% to 120% of the index return. The exact participation rate will be set at pricing.

If the final index level is less than the initial index level and a knock-in event has not occurred, the payout will be par plus the absolute value of the index return.

If the final level is less than the initial index level and a knock-in event has occurred, investors will be fully exposed to the decline from the initial index level to the final index level.

‘Solid offering’

“For a long-term investor, it looks like a pretty solid offering. You get a little bit of leverage. But the structure doesn’t limit your upside. You just give up the liquidity and the timeframe,” said Jerrod Dawson, director of investment research at Quest Capital Management.

Holders of the notes are not entitled to receive cash dividends, according to the prospectus, a term common to almost all structured notes.

“You don’t get the dividends, but if the market is up you get 120% of the upside, which would more than compensate you for that,” he noted.

“If the market was down meaningfully – 10%, 15% or 20% – you would more than offset the non-dividend payment.

“There’s no free lunch, but I think this trade is relatively favorable to investors.”

Six years

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, looked at the maturity first and its implications in terms of lost return compared to an index fund.

“The challenge is the six years,” he said.

“You’re giving up 1.9% in dividend yield. Six years is a long time. You’re talking of giving up 11.4%. That’s significant.”

Unusual

At the same time, the possibility of getting a 29% positive return out of a 29% decline in the index is “unusual” he said.

“You wonder what you’re giving up other than what every structured note investor has to give up, liquidity and dividends.

“I guess if you are willing to invest for six years this note looks like it offers a better risk-return than a direct investment in the index fund.

“If you invest in the S&P, you have all the upside and downside plus the 11.4% from the dividends.

“But on the other hand, the notes give you the upside leverage and the positive return from a zero to 30% index decline, which is nice. The absolute return is worthwhile even if you didn’t have the leverage.

“From a negative perspective, if the S&P goes down, you’re benefiting more than the index. You’re 12% to 30% ahead.”

Chisholm said that ultimately investors have to be willing to invest for the long haul at current market levels.

“The market is overpriced at this level. I’m not saying it’s not going to go higher. But it’s hard to predict what the market is going to be in six years,” he said.

“However, if you’re still bullish on the S&P, if you’re positive about the U.S. over the next decade, then this note is a better way to invest in the market.”

No dividends

A portfolio manager had a different view. He downplayed the value of the absolute return feature based on historical returns.

“I think that getting protection or even a positive return from a 30% index decline doesn’t really matter because I don’t think we’ll be in this scenario at maturity. If we’re down 30% in six years from today, we’ve got bigger problems,” the portfolio manager said.

“The leverage is attractive. You’re getting 15% to 20% premium on your gains. A 20% boost on whatever return you have is pretty good.

“But here’s the problem: you’re not getting the dividend. And we know that 60% of the return from the S&P comes from dividends. That’s the part of these notes that I don’t like.

“Six years is a long time to give up the dividends. It’s a long time to take credit risk too, although I don’t see Credit Suisse going out of business.

“I just don’t like not getting the dividends. That’s why I wouldn’t buy it.”

Expensive feature

He illustrated his case looking at five-year annualized returns on the S&P 500 index from the 2001-06 five-year period to 2008-13.

“You give up the total return to get this absolute return barrier on the downside. I think you’re paying too much for that,” he said.

“If you look at five-year annualized returns, you rarely see steep losses. You had minus 2.19% from 2003 to 2008 and minus 25 basis points in the 2006-11 five-year period.

“Every other five-year period scored positive returns from 41 basis points to 17.94%.

“So what are you gaining really from the downside barrier of this note?

“You’re not going to be down 20%, which would give you 20% gains. That’s not going to happen. It’s more like making a few basis points or even a point or two in return. For that, it’s not worth giving up nearly 2% a year from the dividends.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will price May 22 and settle May 28.

The Cusip number is 22546VBM7.

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