Euro Stoxx likely to be the worst-of in HSBC’s barrier capped notes on FTSE, Stoxx

By Emma Trincal

New York, Dec. 4 – HSBC USA Inc.’s 0% barrier capped market participation securities due Dec. 18, 2025 tied to the FTSE 100 index and the Euro Stoxx 50 index are likely to give investors exposure to stocks in the euro zone rather than in the United Kingdom market, according to contrarian portfolio manager Steven Jon Kaplan, founder of True Contrarian Investments.

If the return of each index is positive, the payout at maturity will be par plus 2 times the return of the lesser performing index, capped at par plus at least 73.44%. The exact cap will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if either index falls by up to 35%.

Otherwise, investors will be fully exposed to the lesser performing index’s decline from its initial level.

“The U.K. is a much cheaper market although it has bounced back since the end of October. We like to buy assets at a discount. The U.K. is no longer a bargain, but it’s definitely cheaper than the Euro Stoxx,” he said.

The FTSE 100 index has gained 33% since its low of March while the Euro Stoxx 50 has climbed 72%. Both indexes have rallied since the end of October, but the Euro Stoxx has gained more.

Currency hedged

The fact that both underliers are indexes rather than exchange-traded funds was advantageous in this note, he said.

Structured notes tied to international indexes benefit from the so-called “quanto” effect, which hedges the currency risk.

According to the prospectus, although the constituents of the underlying indexes are traded in non-U.S. denominated currencies (the British pound and the euro), the amount payable at maturity will not be adjusted for changes in the exchange rates between the U.S. dollar and these currencies. This will remove the exposure to exchange rate risk.

The “currency neutral” aspect of the structure was “very attractive,” according to Kaplan, who is bullish on the dollar.

“The U.S. dollar is extremely low right now, but it will be strong in the next few years. As it will be gaining against other currencies, you are not going to get hurt at maturity. It’s a very good thing. You don’t want to take currency risk on top of market risk,” he said.

The conversion from weaker international currencies into a stronger U.S. dollar will diminish the return for the U.S. noteholder. Conversely, returns get a boost from the conversion when the non-U.S. currencies appreciate against the U.S. dollar.

Structured notes linked to the return of international equity ETFs lack this advantage because the prices of the underlying stocks held in the international funds are converted into U.S. dollars at maturity in order to determine the net asset value of the fund’s components. Investors therefore may be penalized if the U.S. dollar appreciates against the currencies in which the underlying stocks trade.

Picking the laggard

When asked which of the two underlying indexes is likely to be the worst-of, Kaplan said he expects investors will be exposed to the Euro Stoxx 50 index.

“If I had to pick a winner, I would say the U.K. is likely to outperform the euro zone. So, the notes will end up being tied to the Euro Stoxx 50 rather than the FTSE 100,” he said.

“Euro zone stocks are relatively overpriced compared to the FTSE.”

For Kaplan who is a contrarian and value investor, overvalued assets present greater risk of a correction.

“The FTSE has never been so undervalued compared to the U.S. in decades, “he said.

“If you look at the basic ratios – price-to-book or price-to-earnings for instance – the U.K. markets have valuations near those of emerging markets. It shows how unpopular this asset class is.

“Everyone, not just in the U.K, is buying the Nasdaq. It’s only in the past five weeks that we’ve seen a strong rebound for U.K shares.”

Unpopular market

What has led investors to avoid U.K. stocks is not really justified, he said.

“I guess as always, it’s very much headlines-driven. There has been so much noise and confusion around Brexit and the Irish border. Note that none of this has anything to do with the profits generated by companies in the U.K. It’s all about what people read in the Financial Times,” he said.

Meanwhile investors tend to overlook some of the weaknesses in Europe.

“The euro zone’s attempt to have economic unity without political unity has always been a problem. As long as you keep them separate, you’re going to limit the potential for growth in the region,” he said.

European shortcomings

One of the reasons the Euro Stoxx 50 is overvalued in relation to the FTSE 100 index is speculation, he added.

“You have pockets of speculation on some of the weakest European countries while people who buy U.K. stocks are solid, more conservative investors,” he said.

“The more speculators you have in a market, the more overpriced this market is going to be and the more likely it is to drop.”

The euro zone is also a fragmented market, according to the portfolio manager.

“Europe has some problems. You have huge discrepancies between strong economies like Germany and poorly performing ones like Greece or Spain,” he said.

“Diversity is a good thing. I like New York for its diversity. But Europe is a Smorgasbord.

“Market performance, economic strength, public debt levels vary greatly from one country to the other. While everything is in euro, there is no real homogeneity in the region.”

Attractive terms

The structure of the notes was satisfactory, however.

“You get a 65% barrier. Could it be breached? Sure, it could be breached, but in one year or over the short term.

“The fact that it’s a point-to-point observation is a very good thing.

“Within five years we will have a recession and probably plenty of time to recover from it.

“Obviously there is some risk. But it’s going to be a reasonably low risk given the 35% protection and the long investment period.”

He also liked the cap, which represents 11.65% on an annualized compounded basis.

“I think nearly 12% is fairly good. This cap is very reasonable to me for this amount of time,” he said.

Kaplan said he would prefer to invest in the U.K. market directly since there is still value in this asset class.

“I almost bought it recently. But I’d rather wait a little bit more. If the U.S. goes into a correction, which I expect within a few months if not sooner, there is a good chance I would buy some of these U.K. shares,” he said.

HSBC Securities (USA) Inc. is the agent.

The notes will price on Dec. 15 and settle on Dec. 18.

The Cusip number is 40438CK26.

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