Advisers pick their winner between two HSBC leveraged notes tied to Euro Stoxx 50

By Emma Trincal

New York, May 21 – HSBC is readying two leveraged notes on European equity markets, which advisers found both attractive but for different reasons. Each adviser selected a different deal as his first choice. The maturity was the main difference between the two products. Yet the terms rather than the length of the structures constituted the main driver behind their picks partly because no one really can call the end of the nine-year bull market.

Two deals

The first deal is HSBC USA Inc.’s 0% buffered Accelerated Market Participation Securities due Nov. 30, 2020 linked to the Euro Stoxx 50 index, according to an FWP filed with the Securities and Exchange Commission.

If the index increases, the payout at maturity will be par plus 300% of the return, subject to a maximum return of at least 42.5%. The exact cap will be set at pricing.

If the index falls by up to 10%, the payout at maturity will be par.

Investors will lose 1% for each 1% decline beyond 10%.

The second note, which is linked to the same index, matures on May 30, 2023, according to another FWP filing.

Twice longer in duration, this note offers a bigger buffer of 25% and no cap on the upside. The participation rate is lower at 215%.

No crystal ball

“A big factor here is the maturities. A 2.5-year and a five-year... the choice depends on your view,” said Jerrod Dawson, director of investment research with Quest Capital Management.

“Some people pick a time frame based on how long they think this bull cycle will last. But we’re not trying to time the market.”

For some investors it is better to stay short-term in order to catch the last stretch of the boom, he explained. Other clients prefer longer terms on the view that a bear market will be over and a recovery under way by the time the notes mature.

“We try to stay away from those calls. Are we three years left or four years left in the cycle? No one really knows,” he said.

Second one

To be sure both structures are bullish.

“You’ve got to be bullish to invest in any of those notes. If you’re not, you wouldn’t buy any of these.

“If you’re going to invest long-term, I like the second one better. The structure is more beneficial to investors.

“There is no cap. The leverage is pretty close.

“The buffer is generous. Market is down 40%, you only lose 15%. It’s a manageable number most investors can recover from.”

Underlying index

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said he liked both notes but ended up preferring the first one, which has the shorter tenor.

“They’re two good ones, clearly in line with the stuff we like to work with,” he said.

The Euro Stoxx 50 is not Kalscheur’s favorite index. Yet the terms on both products make up for the underlying.

“I’m not a big fan of the Euro Stoxx. It’s just not a high-performing index. It’s not very diversified. We prefer the S&P, which did better historically,” said Kalscheur.

He was referring to performance history and rankings from Morningstar on the SPDR Euro Stoxx 50 exchange-traded fund and the SPDR S&P 500 ETF.

Short-term deal

This led him to pay more attention to the shorter note as it offers more upside leverage than the five-year note.

“Even though it’s not my favorite index, this 3x leverage allows you to capture a pretty strong return. The cap is high enough to actually keep it,” he said.

The 2.5-year note offers a maximum return of 15.22% on an annualized compounded basis. The index only needs rise 4.45% per year to bring investors to this level.

“This structure is really good. The leverage plus the cap offset my dislike for the index,” he said.

As with any structured notes, investors must forego dividends. The Euro Stoxx 50 index yields 2.4%.

“Your buffer is bigger than the 6% you lose in dividends. It’s a small buffer. But it’s enough to make a difference,” he said.

Two out of three times

Part of Kalscheur’s due diligence process when assessing a note is to use back testing. For this product, he looked at the performance of the Euro Stoxx 50 index over the past 18 years based on 30-month trailing periods.

The frequency at which the index finished negative was 38% of the time. A drop in the index price of less than 10% was 9% of the time. The 9% figure measured the full benefit of the buffer.

On the upside, the risk of the index exceeding the 42.5% cap was 30%.

“I want to win two out of three times and this is what I’m getting,” he said.

“If the market is horrible, I’ve got a buffer: I win.

“If the market is flat, say up 4%, I make 12%: I win.

“The market does very well in the lower double-digit: I either win or break-even because my cap is high enough.

“Only if it the market skyrockets, I will only make 15% a year for the next 2.5 years.

“This is a compelling argument for us. I’m not a huge fan of the index but given the leverage, the cap, the buffer, we would consider something like this.”

Usually Kalscheur favors longer-dated structured notes, but not in this case.

Kalscheur said his choice was not dictated by the timeframe as much as the structure.

“The terms are so impressive that even though it’s short-term, we really like it.

“Besides we may have an idea of what the market is going to do three months, six months from now. But 2.5 years, five years? There’s no way we know what the market is going to do.”

Five-year deal

The five-year note was also very attractive, he said. But one needs to be more bullish than he is to accept less leverage and find the uncapped upside advantageous.

“If you’re very bullish you want the no-cap. I’m leaning toward the short-term note because there’s enough leverage to get me 15% from a mediocre market. There is a big difference between two-times and three-times leverage,” he said.

The protective benefit of the buffer was the strong aspect of the product, he added, based on a reading of his back tested data this time on five-year trailing periods.

The Euro Stoxx 50 index fell by more than the buffer threshold 14.4% of the time. Its performance was negative 30% of the time.

“This I really like. You’re cutting your risk of loss in half,” he said.

Encore

But Kalscheur does not just consider downside risk. He wants to see equity-like returns when he invests in the risky asset class.

“Because I’m really not expecting a strong performance from the Euro Stoxx, I’m inclined to prefer the first one. Having three times leverage over that time frame is fantastic.

“If I could get these terms with the MSCI ACWI I would jump all over it.”

The MSCI ACWI index stands for “All Country World index. It tracks 23 developed and 24 emerging markets.

HSBC Securities (USA) Inc. is the agent for both offerings.

Both deals will price on Thursday and settle May 30.

The 2.5-year note carries a 2.75% fee.

Its Cusip is: 40435FZK6.

The five-year note carries a 3.75% fee.

Its Cusip is: 40435FYX9.

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