Credit Suisse’s $1 million contingent coupon buffered autocalls on ETFs seen as too risky

By Emma Trincal

New York, Oct. 13 – Credit Suisse AG, London Branch’s $1 million of contingent coupon buffered autocallable yield notes due Oct. 13, 2023 linked to the least performing of the VanEck Vectors Gold Miners ETF and the iShares MSCI EAFE ETF may not be suitable for conservative investors as the underlying pair of funds pose significant risks, advisers said.

The notes will pay a contingent quarterly coupon at an annualized rate of 15.5% if each asset closes at or above its 80% coupon barrier on the related quarterly observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par if each asset closes at or above its initial level on any quarterly call observation date after one year.

The payout at maturity will be par unless either asset falls by more than 10%, in which case investors will lose 1% for each 1% decline of the worse performing asset beyond the 10% buffer.

Buffer

Tom Balcom, founder of 1650 Wealth Management, pointed to the risk.

“Getting a buffer on an autocall definitely is unique,” he said.

“But I would want more than 10%. It’s just a small buffer for those two underlying. The miners can take you on a roller coaster ride. Getting a 20% buffer would be preferable. I would be more comfortable even if it means having to give up some of the upside.”

Price appreciation

Steven Foldes, vice-chairman of Evensky & Katz / Foldes Financial Wealth Management, agreed.

“These two assets have seen their price rise a lot. There is every reason to expect they could see their share price drop substantially,” said Foldes.

The coupon may be collected only if none of the two funds drops more than 20% on the observation date, he noted.

“It’s quite a challenge to meet those conditions given the performance of those funds, especially as they tend to be very volatile, especially the gold miners.”

Gold miners’ stocks have strongly rallied this year as profits have surged with the rising price of the precious metal. Gold is up 29% year over year.

The gold miners ETF has incurred a correction since early August but has rallied since the end of last month.

“A 20% drop for this ETF is not unusual,” he said.

Volatility

As an example of its volatility, the gold miners ETF saw its share price plunge 48% during the pandemic-induced sell-off from Feb. 24 to March 16. Even if the entire market fell into bearish market territory then, the S&P 500 index during the same short period of time was down 35%.

The upside also showed a markedly volatile performance for this fund. Since its March low, the ETF gained nearly 150%. Because of the steep drop in February and March, the fund is “only” up 37% for the year to date. That’s considerably high compared to the S&P 500 index, which has only returned 8.7% this year.

Going back three years ago, the fund has only gained 19% due to a long bearish trend from 2011 to 2016.

The EAFE ETF gained 38.5% since its low of March.

“Those funds have seen big runs. You can potentially see some decline in one or both,” he said.

The implied volatility of gold miners fund is 41.54%. More muted, the volatility of the EAFE fund is 19.71%.

The buffer at maturity did not offer enough protection, Foldes added.

“It’s 10% on the worst of the two. It’s unlikely that the stock market would be down three years from now. But you’re talking about an asset whose price is tied to the price of gold. With the rally we’ve had in gold, there is definitely the potential for significantly more than 10%.

“The EAFE is not as volatile as the gold miners. But both have significantly appreciated. So, the coupon payment may be problematic, and the 10% buffer is not enough,” he said.

Dispersion

He mentioned another important risk factor.

“Those two funds are not very correlated, which creates a significant risk. One of the two could do well and not the other. And the exposure is to the worst of the two,” he said.

Indeed, the two underlying funds show a low correlation with a three-year coefficient of only 0.416.

“This is not like getting the worst of the S&P and the Russell.”

The two indexes, which are commonly used in worst-of deals, have a coefficient of correlation of 0.917.

“It’s nice to have a hard protection at maturity, but in this case, I’d rather have a 30% barrier than a 10% buffer,” he noted.

“All those factors, the high valuations, the volatility, the low correlations are problems. It’s not something that we would find attractive. The 15% coupon is nice, but I’d much rather have the upside participation given the risks.”

Shorting a put

Other strategies capping the upside could end up paying off more.

With an option play consisting of selling an out of the money put at a strike of $36, corresponding to the 90% buffer level (the gold miners ETF closed on Tuesday at $40), an investor could earn a significantly higher return. The $7.60 premium associated with a Jan. 20, 2023 put contract at a strike of $36 would yield a 26.75% return and this would be over an investment period nearly nine months shorter, noted a source.

“Terms are certainly better with options because you don’t have the fees. But structured notes are much easier to manage,” said Balcom.

“You can’t put options in retirement accounts. Some accounts can’t have options or have limitations. They’re not easy to manage.”

Asset allocation

The main issue with the note, he said, was the excessive level of risk.

“A 15.5% sounds really appealing when you look at Treasury yields that pay next to nothing.

“But you get paid for the risk.

“Personally, I would try to squeeze out some of the risk. I’m more concerned about the downside risk than the upside return.

“You could look at the 15.5% coupon as high-yield replacement except that it doesn’t belong to a fixed-income portfolio given the risks involved.

“As an equity investment your upside is capped. You don’t participate in the gains.

“So, this would not be something we would consider unless you can find a way to mitigate the risk. But that would be a different deal.”

Credit Suisse Securities (USA) LLC is the agent.

The notes settled on Oct. 13.

The Cusip is 22552WPF6.

The fee is 0.7%.

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