Credit Suisse, HSBC price notes on EM index, fund with advisers weighing leverage, barrier

By Emma Trincal

New York, Jan. 2 – Issuers recently priced leveraged notes tied to the emerging markets asset class with some form of downside protection, however the tenors, protection type and upside potential varied greatly from one issue to the other. Advisers commented on each structure based on their own outlook.

The first deal, which priced at a higher size, was longer in duration with unlimited upside and a downside barrier.

Credit Suisse AG, London Branch priced $7.8 million of 0% trigger gears due Dec. 31, 2024 linked to the MSCI Emerging Markets index, according to a 424B2 filing with the Securities and Exchange Commission.

If the index return is greater than zero, the payout at maturity will be par of $10 plus 1.3 times the index return. Investors will receive par if the index declines by 25% or less and have one-to-one exposure to the index’s decline from its initial level if it declines by more than 25%.

Shorter, buffered

The second offering, of a shorter maturity, was capped on the upside. It had slightly more leverage on the upside and offered a hard protection on the downside.

HSBC USA Inc. priced $825,000 of 0% buffered Accelerated Market Participation Securities due June 27, 2022 linked to the iShares MSCI Emerging Markets ETF, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus double any ETF gain, up to a maximum payout of 20%.

Investors will receive par if the ETF falls by up to 10% and will lose 1% for every 1% decline beyond 10%.

More leverage

Steve Doucette, financial adviser at Proctor Financial, said he would be inclined to choose the longer-dated note but not with the terms offered by this issuer.

“I’m surprised it only has 1.3 times leverage for a long duration. There’s no cap, but still. You’d think you could get better than that,” he said.

“The downside protection doesn’t seem that great either for a five-year. I guess volatility has come down.”

While market conditions modify terms of deals, advisers who have secured attractive structures in the recent past are reluctant to consider products when the optics are less appealing.

“Not a long time ago, we were able to get a three-year one on emerging markets with a shorter term and more leverage. Even though it had a cap, it was a 42% cap on a three-year and you had two-time leverage with a 35% barrier on the downside,” he said.

“Pricing is going to be impacted by the market, I realize that. But I can’t get too excited when I compare this with terms we have in place.”

Low cap

Doucette was not very enthusiastic either about the second offering featuring 2x leverage over two-and-a-half years with a 20% upside cap and a 10% buffer.

“If you think the emerging markets are going to run for another two or three years, that’s not a very high cap,” he said.

The capped return is 7.57% a year on a compounded basis.

The iShares MSCI Emerging Markets fund gained 17% last year, or nearly twice less than 29% for the S&P 500 index. But this fund can post high returns as it did, for instance, in 2017 with a 37.3% gain.

Changing the risk-reward

“On the downside, 10% isn’t that much for such a risky asset class,” said Doucette.

The ETF’s last negative year was in 2018, with a 15.3% loss. In 2015, the fund was down 15.4% and it lost 19% in 2011. But drawdowns can be much worse due to the extreme volatility of the asset class. For example, the iShares MSCI Emerging Markets ETF lost 50% in 2008 compared to an already steep decline in the S&P 500 index down 38% on that year.

Doucette said emerging markets have upside potential, which made him rule out having a cap on the upside.

Extending the duration was a better outcome than limiting gains, he explained.

“I would go for the longer-dated one. Five-year. For that timeframe I wouldn’t be so concerned about the downside, although you never know. But I probably would want to get more leverage and see how much more I could get if I reduce the barrier for let’s say 80% as opposed to 75%.”

A buffer is a must

Matt Medeiros, president and chief executive of the Institute for Wealth Management, did not have any particular preference for one or the other deal.

“I like the asset class. I’m pretty optimistic about emerging markets over the next couple of years.

But I don’t necessarily like either one of them,” he said.

His priority was to solidify the downside through the use of a hard protection.

“For the Credit Suisse one, I’d prefer to have a buffer as opposed to a barrier,” he said.

Same protection size

Since the note has a long maturity, he said switching to a buffer should not lead to sacrifice too much in protection amount.

“I think the buffer wouldn’t have to be smaller or at least not that much smaller. I think for a five-year, you should be able to get a 20% to 25% buffer.”

If it meant having to cap the upside, Medeiros said the tradeoff was acceptable as long as the level of the cap was reasonable too.

“I wouldn’t mind a cap if it’s a cap that’s in line with historical returns on emerging markets.”

Value play

While emerging markets have been rallying since the fall, the asset class has not shown a strong, long-term bullish trend for some time. The ETF is still below its high of January 2018. The fact that the asset class has underperformed U.S. stocks is a good sign, he said.

“I like emerging markets. It’s a valuation play.

“There are opportunities there. If this trade deal gets done, the big headwinds will be behind us. So, I’m pretty optimistic both from a valuation standpoint and from a political standpoint.”

UBS Financial Services Inc. is acting as distributor for the Credit Suisse deal.

The notes (Cusip: 22550K731) settled on Dec. 31.

The fee is 3.5%.

HSBC Securities (USA) Inc. is the agent for the HSBC offering.

The notes (Cusip: 40435UR89) settled on Dec. 27.

The fee is 2.25%.

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