Credit Suisse’s contingent coupon callable notes on ETFs designed for aggressive risk profile

By Emma Trincal

New York, Sept. 1 – Credit Suisse AG, London Branch’s contingent coupon callable yield notes due Sept. 25, 2023 linked to the SPDR S&P Biotech exchange-traded fund and the Technology Select Sector SPDR fund offer a “high-return, high-risk” profile, which makes the product more suitable for an equity than a fixed-income portfolio, advisers said.

The notes will pay a contingent coupon at the rate of 13.35% per year if each fund closes at or above its coupon barrier, 70% of its initial level, on a semiannual observation date, according to an FWP filing with the Securities and Exchange Commission.

The notes are callable at par semiannually.

The payout at maturity will be par unless the least-performing fund finishes below its knock-in level, 70% of its initial level, in which case investors will lose 1% for every 1% that the least-performing fund declines from its initial level.

Issuer call

Tom Balcom, founder of 1650 Wealth Management, said that the discretionary call helped secure a higher yield.

“It’s the issuer that decides to call, but at least there won’t be a call in the first six months. Your first coupon and the last one if they call you at that point is going to be at least 6.7%. In six months, that’s more than 10 times the 10-year Treasury yielding 0.62,” he said.

Correlation, volatility

One of the risks with worst-of is a low or negative correlation between the underlying.

“You would think the two ETFs are correlated. But that’s something that needs to be examined closely,” he said.

In fact, the one-year correlation between the two funds is only 0.675, according to FactSet.

Balcom pointed to the volatility inherent to the two sector funds.

Both show implied volatilities in the 30’s.

“A 30% barrier is pretty good, but you have a lot of volatility there,” he said.

Robust rebounds

The technology ETF (ticker: XLK) dropped 34% from its February high to its low of March, and the biotechnology fund (Ticker: XBI) lost 36% during the same time.

“They dropped a lot, but they rebounded even stronger. That’s also volatility,” Balcom said.

The XBI ETF surged 92% from its low of March to its 52-high at the end of July.

The XLK fund hit a new all-time high on Tuesday, which makes for a 126% price surge since March.

For the year to date, the XLK fund has increased by 37% and the XBI by 15%.

Not cheap

Getting exposure to the two funds was not exactly value investing, he said.

“Valuations are a concern especially for technology,” he said.

“Investors are not buying cheap assets. Apple has a P/E of 40...

“If we have a second wave of coronavirus, volatility could be a concern.”

Not income

Overall investors should assess the risk carefully and allocate the notes to the right portion of the portfolio.

“Chances are you’ll get paid some coupons,” he said.

“But you have to be aware of the risk. This is not fixed income.

“Three years from now, the probabilities of being above the 70% barrier are quite high.

“I can see it as an equity replacement, not as a fixed-income replacement.”

Concentration

Donald McCoy, financial adviser at Planners Financial Services, said the risk-adjusted return of the notes was fair. But he would be extremely cautious.

“The 13.35% coupon is certainly a healthy yield,” he said.

But the return was commensurate with the risk, he added.

“The biotech one is much more volatile than the other,” he said.

He pointed to a 52% price drop between July 2015 and February 2016. Just last spring, the conditions for a barrier breach could have been met.

“This is a spicy index. The possibility of big market swings is there,” he said.

Another important detail was the composition of the technology ETF.

“This one carries some kind of concentration risk. Almost half of the fund is in Apple and Microsoft,” he said.

Apple Inc. and Microsoft Corp. have 25.27% and 20.55% weightings, respectively. The third largest holding, Visa Inc., drops to a much smaller allocation size of 4.3%.

“You might as well buy the two stocks,” he said.

Smaller stocks

Another concern with the biotech fund was its exposure to smaller, lesser-established companies.

The top holding for the biotech fund is Novavax Inc., one of the biotechnology firms engaged in the search for a Covid-19 vaccine along with a long list of competitors such as Moderna, Inc., which is included in the fund, as well as Vir Biotechnology, Inc. and AstraZeneca plc, which are not.

Entry price

Five months ago, when the market was at a bottom, McCoy would have felt more comfortable about the downside risk.

“The likelihood of being down 30% from the lows in March was limited at the time since you were getting in at a pretty decent discount.

“But now, the technology fund is at an all-time high. The biotech is off since the end of July. But it’s still 75% higher from March.

The fund closed at $109.56 a share on Tuesday.

Use with moderation

“With something as volatile as the biotech ETF obviously they’re trying to compensate you generously with this 13.35% a year.

“You could stand to do nicely with that type of return as long as you stay above the barrier.

“But if you are a conservative investor hungry for yield, this may not work for you given the high return-high risk profile of the structure.

“You’re kind of rolling the dice.

“I would only feel comfortable putting only a small portion of my portfolio in this or finding something that doesn’t offer as much on the upside but comes with less risk on the downside,” he said.

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on Sept. 18 and settle on Sept. 23.

The Cusip number is 22552WHB4.

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