Credit Suisse’s knock-out notes tied to Russell 2000 offer defensive play on small-cap stocks

By Emma Trincal

New York, Dec. 9 – Credit Suisse AG, London Branch’s 0% capped knock-out notes due Dec. 28, 2017 linked to the Russell 2000 index allow investors to make a bullish bet on the U.S. small-cap benchmark with a competitive level of protection given the short tenor, said Tim Mortimer, managing director at Future Value Consultants.

A knock-out event will occur if the final index level is less than the initial level by more than the knock-out buffer amount, which is expected to be 20% and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

If a knock-out event has not occurred, the payout at maturity will be par plus the index return, subject to a minimum payout of par and a maximum return that is expected to be 16.88% and will be set at pricing. If a knock-out event has occurred, investors will lose 1% for every 1% that the final index level is less than the initial index level.

Cap, barrier

“It’s about market view,” Mortimer said.

“The advantage of this product is that you have the first 20% of the downside protected. Then of course if you go through the barrier, the protection doesn’t apply anymore.”

The product offers a trade-off: investors are protected up to a 20% decline in the index. In exchange, they agree to see their gains capped at 16.88%.

“Most people would be happy with 17% over one year. It’s pretty high,” he said.

The upside cap is not quite the same as the 20% barrier threshold but close enough.

“Investors expect returns in the 20% range up and down for next year,” he said.

“It doesn’t really break that range. You’re not likely to hit the cap, and if you do, it doesn’t really hurt you that much. One the downside, chances are you will have enough.”

Risk

Future Value Consultants evaluates risk, return and price using a variety of proprietary scores in order to compare a product with its peers and also the general population of products. The notes belong to the leveraged return category, which is defined as notes having an upside participation rate of more than 100%.

The firm calculates the market risk and the credit risk and adds the two components to generate the “riskmap,” which measures on a scale of zero to 10 the risk associated with a product with 10 as the highest level of risk possible.

The notes have a 1.90 market riskmap versus an average score of 1.59 for the product type, according to Future Value Consultants’ research report.

“It shows more market risk than similar products, probably because the average has a longer maturity, which reduces risk in the way we measure it, and also a deeper barrier,” he said.

On the other hand, the 0.32 credit riskmap is slightly better than the 0.37 product type average. The score also indicates less risk than the average for all products, which is 0.39.

Adding the components gives a 2.22 riskmap, which is slightly more than the average of 1.96 for the product type but less than the 2.88 average for all products.

Return score

The return score measures the risk-adjusted return of a note on a scale of zero to 10 with 10 as the best possible score.

The notes’ return score is 7.47 versus an average of 7.42 for similar products and 6.68 for all products.

“The 17% upside for a one-year is not bad. In addition, you receive a lot of protection. Twenty percent for one year is pretty significant. Both factors give you a better risk-adjusted return than the average,” he said.

Value

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10, with 10 offering the best pricing.

This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

At 8.56, the price score is lower than the 8.80 average for the same product type but much higher than the average for all products of 7.35, the report showed.

“The pricing is pretty competitive,” he said.

“It’s a one-year trade on a major index where you have plenty of options. The hedging is very easy. You can get calls and puts on a one-year basis pretty easily.

“Since it’s a very liquid, very transparent market it would be obvious if the trade was uncompetitive.”

Overall

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. It is the average of the price score and the return score.

The notes have an overall score of 8.01 versus an average of 8.11 for the product type and 7.02 for all products.

“It’s doing very well compared to all products,” he said.

“The fact that it offers a high cap gives investors quite good return prospects.

“The S&P 500 has been very strong. Investors want to diversify, and the Russell is always a popular choice.

“For someone who wants to invest in the Russell but needs some downside protection, this is an attractive deal.”

J.P. Morgan Securities LLC and JPMorgan Chase Bank, NA are the agents.

The notes were scheduled to price Dec. 9.

The Cusip number is 22548QQG3.

© 2015 Prospect News.
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