Credit Suisse’s PLUS tied to Topix offers access but entry point, valuation may not be best

By Emma Trincal

New York, June 29 –Credit Suisse AG, London Branch plans to price 0% trigger Performance Leveraged Upside Securities due Oct. 3, 2018 linked to the Tokyo Stock Price index, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 300% of any index gain, up to a maximum return of 17.6%. Investors will be fully exposed to losses.

The Topix or Tokyo Price index is a capitalization-weighted index for large-cap stocks on the Tokyo Stock Exchange.

Access

Part of the appeal of the notes may be the exposure, sources said.

Investors in the United States have little to no access to the Topix via exchange-traded funds.

In the past, the iShares Japan Large-Cap ETF used to track the S&P Topix 150 index. But this fund changed its name into iShares MSCI Japan.

BlackRock, the ETF sponsor changed at the same time the reference index, which is now the JPX-Nikkei 400 Total Return Index. This index offers more exposure to mid-cap and small-cap Japanese equities than the previous large cap-focused S&P Topix 150 Index.

Return enhancement

The structure was designed to boost the upside in a slow-growth market.

“If you’re a bull or slightly bullish, it’s a great strategy. You only need a little bit of a bump,” said Steve Doucette, financial adviser at Proctor Financial.

The 17.6% maximum return provides investors with a 13.85% annualized cap on a compounded basis. This level can be achieved if the index rises by a mere 4.65% a year.

For Doucette, the risk of limiting one’s upside was small.

“I can’t imagine it would go up more than 17% over the course of 15 months. You only need this index to go up a little bit, not much. That’s kind of nice.”

Diversification

From an asset allocation standpoint, Doucette believes in diversifying away from domestic stocks. He continues to allocate more into international equity as U.S. benchmarks keep on hitting new highs.

“But we typically do broader allocations. We don’t do one country. It’s more like international stocks or to Europe,” he said.

Doucette said he does not follow the Japanese stock market. But after the 2008-09 crisis, the chart showed a flatter, less bullish trend than the S&P 500 index.

“Japan has been up and down over the last few years. I would have to do more research on it.”

Investors in the notes do not need to be very bullish. But they have to be confident enough to be exposed to the full downside risk, he said.

Sector proxy

One thing Doucette said intrigued him about Japan was how correlated this market was with the financial sector as a whole.

He referred to a presentation he heard at a seminar. The speaker, Jeffrey Kleintop, chief global investment strategist at Charles Schwab & Co., Inc., was saying that “Japan tends to perform like the financial sector.”

The strategist plotted the performance of the MSCI World Financials index and the MSCI Japan index. The chart showed tightly intertwined returns from January 2006 to January 2017.

“I guess you need to have a view on banks. Japan is a financial-based economy. If you think that with rates going up banks are going to generate more profits and that we’re not looking for a recession yet, you might want to capitalize on that.”

Risky bets on rates

But he was not so sure about that theory.

The Bank of Japan has been implementing a strong monetary stimulus since 2012. In January 2016, it initiated an even more aggressive measure by launching a negative interest rate policy. Earlier this month, the central bank kept interest rates on hold, which analysts interpret as a pause, not an end to the monetary stimulus.

Rising interest rates tend to increase banks’ profits as long as funding costs do not rise excessively.

Since the future of Japan’s interest rate policy is far from clear and that the country has negative interest rates, predicting the direction of the stock market on the view that it is highly correlated with bank stocks, may be hazardous, concluded Doucette.

Relative value

Brian Rettig, portfolio manager at the Institute for Wealth Management, did not like the structure of the notes.

“It’s very short-term, highly leveraged but it has no protection,” he said.

Valuation would have to be very compelling to make the notes attractive, which he did not think was the case.

An argument could be made that it was sensible to diversify away from U.S. stocks to a number of foreign equity markets, including Japan.

But this argument would have to be reexamined as Japanese stocks may not be so cheap anymore.

Quoting the MSCI Japan fund, which is highly correlated with the Topix, Rettig said that Japanese stocks have outperformed the S&P 500 so far this year, being up 10% versus 8% for the U.S. benchmark, which is not a large gap.

Similarly the performance of the two indexes is very tight over the past year with the MSCI Japan fund up 18%, versus 19% for the S&P 500 index.

Buffer wanted

“You still have valuation a little bit in your favor. But I don’t think it’s a great entry,” he said.

“I’d rather have protection on the downside rather than leverage on the up.

“If you’re outright bullish, just buy the ETF.”

One positive factor however, which could provide “some support” to entering this trade, was the recent momentum showing money flowing into overseas markets, he noted.

“Maybe there’s a bid there and a little bit more room to go. If you picture five to 8% over the next year, this would be appropriate.

But he still would need the protection, aiming at a 15% to 20% buffer.

Since getting a buffer this size over a short period of time on a moderately volatile index would be impossible, he suggested extending the maturity to three and a half to four years.

Reducing the leverage would probably be part of the tradeoff as well, he said.

Credit Suisse Securities (USA) LLC is the agent with Morgan Stanley Wealth Management handling distribution.

The notes will price on Friday.

The Cusip number is 22549C337.

© 2015 Prospect News.
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