Credit Suisse's Bares linked to Russell 2000 are designed for bullish play on small-cap stocks

By Emma Trincal

New York, July 2 - Credit Suisse AG, Nassau Branch's 0% Buffered Accelerated Return Equity Securities due Aug. 5, 2014 linked to the Russell 2000 index offer an attractive risk/reward profile for bullish investors seeking small-cap exposure, sources said.

The payout at maturity will be par plus double any index gain, up to an underlying return cap of 33% to 37%. The participation rate is expected to be 200%. The exact rate and cap will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 10% and will be exposed to any losses beyond 10%.

Carl Kunhardt, wealth adviser with Quest Capital Management, said that he likes the terms of the product. However, his outlook is not sufficiently bullish to entice him to buy the notes.

Volatile benchmark

"As a product, I like it. It's simple, easy to explain," he said.

"My only concern is the liquidity even though two years is very short. That's because of the underlying - the small-cap benchmark. It's a volatile index.

"Take this morning. The manufacturing index was down. It's the sign of slowing economic activity. We are in a weak market, and that added one more nail in that coffin."

The Institute for Supply Management released its index on Monday, which dropped to 49.7 from 53.5 in May - way below expectations and less than the critical 50 mark, which tends to indicate a contraction.

"Otherwise, it's the kind of product I would look for. There's a reasonable downside protection, and anytime you have that, you get a cap. But a 17% cap a year, that's pretty attractive," he said.

Kunhardt said that his hesitation has to do with the performance of the U.S. small-cap equity space in relation to the economic cycle. When the economic environment declines, "small caps are the ones that are going to slow down first," he said.

"It's a small-cap play, and I'm not sure I'm up to it if we're going to have an economic downturn," he said

Asked whether he would prefer a larger buffer with a lower cap, he replied: "It depends. If I was trying to hedge the risk, I'd prefer the larger buffer with a lower cap. But if I was trying to juice the performance of the portfolio, rather than using these notes, I would probably buy the index outright or buy options."

Attractive upside

Michael Kalscheur, financial adviser at Castle Wealth Advisors, is more optimistic about the performance outlook of the underlying benchmark, saying that the upside potential outweighs the downside risk.

"A 10% buffer is the bare minimum we would be looking for, but that's not a bad situation," Kalscheur said.

"When evaluating a buffer, you have to ask yourself, what are the odds that two years from now, the index will be down by more than 10%?

"If you're up over two years or break even or down in the single digits, a 15% or 20% [buffer] doesn't do you any good. In fact, what it will do is limit your upside quite a bit.

"So in a bad situation, sure I'd rather have a 15% or 20% buffer. But it depends on your view. If you're bullish, those terms are particularly attractive."

On the upside, investors with an assumed cap of 35% can expect a 17.5% annualized return at the most. It would take half of that performance for investors to achieve this maximum potential, or about 8.75% per year.

The Russell 2000 is up 7.65% year to date.

"A lot of the products I've seen based on the S&P 500 or the Dow Jones tend to give you 100% to 150% participation with a 12% cap per year. That's kind of the historical average. You're betting that the index is not going to do that well. You have to be a lukewarm bull to be investing in notes like these," Kalscheur said.

"This one has a 17% upside. It's pretty aggressive. None of my clients are going to be mad at me for that."

Other things

Kalscheur said that he would consider other factors before considering the notes for his portfolio.

The first one is the amount of dividends the noteholder will be giving up. In the case of the Russell 2000, the 1.55% dividend yield leads to a loss of a little bit over 3%.

"You still outperform the index if the index is down," he said.

"If it's up, you beat it because of the leverage unless the index is above the cap, but it's a pretty high cap even if you subtract the dividends.

"You're giving up 3%, but you're getting 10% downside protection and a lot of upside. It looks pretty good to me."

Investors should also consider the amount of fees and the level of the index on the day of pricing, he noted.

The creditworthiness of the issuer, rated A+ by Standard & Poor's, is also a main factor.

"The only concern I would have here is the issuer's credit risk," he said.

"Everybody knows of the potential problems European banks have.

"But that's something you need to consider with any structured note. And it's only a two-year product.

"The duration, the terms are very good. Depending on where it strikes, it could be a very nice addition to an actively managed small-cap exposure."

Credit Suisse Securities (USA) LLC is the underwriter.

The notes will price July 31 and settle Aug. 3.

The Cusip number is 22546TWA5.

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