Credit Suisse’s notes on EAFE index have advisers say that buffers matter more than the upside

By Emma Trincal

New York, July 11 – Credit Suisse AG, London Branch’s $2.14 million of 0% leveraged buffered index-linked notes due June 7, 2024 tied to the MSCI EAFE index offer an attractive cap and leverage factor, but advisers said the potential gains on the upside were not as important as the quality of the buffer, which they thought lacked strength given the exposure to developed markets, which are vulnerable to more geopolitical risks.

The payout at maturity will be par plus 180% of any index gain, up to a maximum settlement amount of par plus 35.1%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index finishes flat or falls by up to 15% and will lose 1.1765% for each 1% decline beyond 15%.

One adviser said the notes were not defensive enough.

“My inclination to buy structured notes is to get the protection. Here the leverage and the cap are fair. But I don’t think the upside gains are worth getting what I view as a lack of protection,” said Scott Cramer, president of Cramer & Rauchegger.

A proxy for Europe

The geared buffer was the structure’s main weakness, for this adviser.

He pointed to an imbalance between upside and downside in the pricing of the product.

“I don’t like the tradeoff. The amount of protection is okay. But I don’t like the gearing. If things go really bad, your losses will compound quickly. And for what? The cap is good, but you may not hit it.”

The need to have solid downside protection is greater during a crisis. Stock markets are selling off worldwide and the global economy is slowing down, he noted. But Europe is more at risk than many other parts of the world, he added, which has implications with this note given the weight of Europe in the MSCI EAFE index.

The United Kingdom, France, Switzerland, Germany, the Netherlands, Sweden, Denmark, Spain and Italy all combined make for 61% of the MSCI EAFE index.

Energy crisis

The dependance of European countries for natural gas was the most visible geopolitical risk, he said.

“If Russia continues to weaponize energy supplies, Europe is going to be in trouble. I don’t see how it’s not going to be an issue.

“They’re going to have food issues. They’re going to have energy security issues.”

As he spoke, news broke that Russia momentarily shut down the supply of natural gas to Europe through the Nord Stream 1 pipeline on Monday in order to conduct maintenance work.

“Russia could try to inflict more pain on people as the war in Ukraine drags on. Europe would be the first domino to fall,” he said.

Geopolitical risks

Carl Kunhardt, wealth adviser at Quest Capital Management, was also concerned about the region.

“I would do it if it was just for the structure. But I wouldn’t bet on the EAFE at this point,” he said.

“I have no issue with the cap. I have no issue with the buffer although I don’t like geared buffers. But if it was a regular market, I’d take the gear.”

He noted that the EAFE is “mostly Europe,” adding that he was “not optimistic” about Europe, especially for the next two years.

“They have a war that doesn’t seem to be going anywhere. The United Kingdom is going through a political crisis and so is France. Skyrocketing gas prices are disrupting the entire region,” he said.

For this adviser, the sovereign debt crisis that emanated from Greece a decade ago has yet to be resolved.

“Spain and Italy have never fixed their debt issues and they’re much bigger economies than Greece,” he said.

“Europe has a monetary union, but its fundamental problem is the lack of a fiscal union.

The adviser did not rule out the possibility of a new debt crisis in Europe.

“Some NATO countries have said they will raise their contribution to 2% or even more. Where is the money going to come from?

More headwinds

Kunhardt sees more dangers on the horizon.

“Russia continues to be a threat. Who says they will stop at Ukraine? They want the old Eastern Europe back, and that includes Poland, Lithuania, or Estonia, which are NATO countries. That could be a serious war.”

Kunhardt said geopolitical problems are looming in Asia as well, with Hong Kong and Singapore constituents of the index albeit in small weights. But Japan is the top country with a 22% weight.

“China is making threats to Japan and to Taiwan. The threats to Taiwan are overt,” he said referring to China’s defense minister saying last week that his country would “not hesitate to start a war.”

“The threats to Japan are not overt. But they’re still threats. China knows that they have a golden window of opportunity to strike before the 2024 U.S. Presidential Elections.

“They already built up their military presence in the South China Sea.

“Why would you be optimistic about those two markets and buy a note with a geared buffer. With big losses, your investment can go down to zero.”

Allocation, gearing

Kunhardt who considers himself as an asset allocator first would still invest a portion of his portfolio in the MSCI EAFE index.

“You need to participate. Any portfolio has to have international equity. I would still do a structured product on the EAFE but not this one,” he said.

“Even if you see risks, you can’t just withdraw from the world otherwise what you’re doing is timing the market. Timing the market is getting out, which is easy and getting back in at the right time, which is not. Nobody gets that second decision right.

“When you’re an asset allocator, you check your goals, you check your asset allocation, and you make sure they’re aligned.

“You put your head down and run through it.

“That’s when you need a structured note with a good buffer.

“I would do it with a straight buffer. Not with the gearing."

Bearish view

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, said he can’t find buffers large enough to warrant his attention.

“A 15% buffer is insufficient. I’m okay with the two-year term because beyond one or two years, it’s nearly impossible to predict anything. So, the tenor is fine.

“The leverage is okay. But it’s irrelevant.

“Getting the leverage is not as attractive as getting a very good buffer.”

He explained why.

“I see another 40% to 60% drop from here. Why would I care about the leverage?

“Give me a 40% buffer and I’m good.

Credit Suisse Securities (USA) LLC is the agent.

The notes settled on July 11.

The Cusip number is 22553QAR8.

The fee is 0%.

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