Credit Suisse’s absolute return buffered notes on Euro Stoxx offer hedge for cautious investors

By Emma Trincal

New York, Aug. 27 – Credit Suisse AG, London Branch’s 0% absolute return buffered securities due Sept. 2, 2021 linked to the Euro Stoxx 50 index provide buyers of absolute return products a rare buffer on a relatively short maturity. The trade-off is a modest upside potential with no return enhancement feature.

If the index finishes at or above its initial level, the payout at maturity will be par plus the index return, capped at par plus 15.25%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index falls by up to 15%, the payout will be par plus the absolute value of the return.

Otherwise, investors will lose 1% for every 1% decline of the index beyond 15%.

Absolute return, buffered

“We do invest in the Euro Stoxx for diversification purposes. The index has been a laggard though compared to the domestic market,” said Tom Balcom, founder of 1650 Wealth Management.

“We just sold one leveraged note on the Euro Stoxx for a profit. But this index is not a high performer.”

Yet advisers may want to buy European stocks as part of their asset allocation routine.

“This note is attractive on the downside. If you need exposure to European stocks and don’t know which way the market is going, this gives you a good protection.

“You give up the dividend yield, but it’s only for two years.”

Modest upside

“Naturally, there is the other side of the coin. Your upside is not going to be as good,” he said.

“It’s one-for-one. No leverage. You miss the 2.88% dividend yield. That’s about 5.75% over the term. And you’re capped.”

The 15.25% cap over two years results in a small maximum return of 7.6% per year. But the performance of the Euro Stoxx 50 index has been less than stellar, he noted.

The underlying index has returned in the past 10 years an average of 4.9% a year, according to Morningstar.

“This is not a get rich quick thing,” he said.

“If you’re looking to make a killing, you’re in the wrong trade.

“It’s to hedge your exposure to the Euro Stoxx, first and foremost.”

Hedging seems appropriate for this asset class.

“Europe, with its negatively yielding interest rates and its debt, has some unresolved issues,” he noted.

“I’d rather have a buffer. I can check the box ‘downside protection’ and still make money if it goes south.”

Real hedge

Balcom said the buffer provided a “hard” protection while the absolute return offered a “real hedge.”

“If the index is down 15%, you’re up 15%. You outperform by 30 points.

“There’s a real benefit in investing in those absolute return [notes], especially in this environment with an inverted yield curve, negative interest rates overseas and a not-so-bullish market due to the uncertainty.”

No barrier

One striking aspect of the structure was the ability to price both the absolute return feature and a buffer over a short maturity, said Jonathan Tiemann, president of Tiemann Investment Advisors, LLC.

“Of course they have to chop off your upside to give you those benefits on the downside,” he said.

Absolute return notes almost always come with a barrier, at least on the commonly used S&P 500 index, according to data compiled by Prospect News. The two-year tenor is also below average. The average maturity this year for those products is three years. While one-to-one exposure is not uncommon, the use of the Euro Stoxx 50 is much less frequent than the S&P 500.

Forward

“The options are cheap because interest rates in Europe are negative,” he said.

“The dividend is high. They’re able to collect a rich dividend over two years.”

Both factors make the forward quite cheap, he added.

The forward of an asset on the basis of which structured notes are priced will see its value rise with the interest rates and decline with the dividend. Based on a complex calculation, negative interest rates and high dividends will contribute to reduce the value of the forward contract.

“That’s how they can price it.”

Conservative

Regardless of pricing, the end result was a reasonably attractive note, he said.

“I find it very interesting actually. The cap is low, but they had to price it that way in order to pay for the inverse return from zero to minus 15 ... the absolute return,” he said.

“This is a pretty conservative note. It’s not for a raging bull.

“But if you want to invest in Europe and are still cautious, it’s not a bad deal.

“You recognize you’re giving up a chunk of the upside. There is no leverage, no digital.

“But it’s a relatively short-term note. If 15% seems modest, it’s because it’s just two years.

“I kind of like it.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on Friday

The Cusip number is 22552FU67.

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