HSBC’s performance allocator notes on U.S., Europe, Asia Pacific seen as similar to ‘best of’

By Emma Trincal

New York, Jan. 3 – HSBC USA Inc.’s 0% performance allocator notes due Feb. 7, 2022 linked to three baskets of regional indexes offered what seemed like the “reverse” outcome of a worst-of to advisers and one they welcomed.

Even if technically investors are not fully exposed to the performing underlying they still get the greatest exposure to it, they noted.

“I like the concept. It’s unique,” said Tom Balcom, founder of 1650 Wealth Management.

The U.S. basket consists of the S&P 500 index and the Russell 2000 index. The Europe basket consists of the Euro Stoxx 50 index and the FTSE 100 index. The Asia Pacific basket consists of the S&P/ASX 200 index and the Nikkei 225 index.

Each index will have a 50% weight within its respective basket. An allocated return of the baskets will be calculated based on the performance of all three baskets, with the best performing basket to be given a 60% weight, the second best a 30% weight and the worst a 10% weight, according to an FWP filing with the Securities and Exchange Commission.

If the allocated return is positive, the payout at maturity will be par plus the gain.

If the allocated return falls by up to 15%, the payout will be par.

Otherwise, investors will lose 1% for each 1% decline of the allocated return beyond 15%.

Worth explaining

“It’s very attractive,” said Balcom.

“The only difficulty would be to explain it to clients. You have to go through the intricacies on how this note is structured. Each basket has two indices and the final return is not the simple average of the three baskets but a weighted average. What matters is that it works to your advantage.”

This adviser said the easiest way to explain the structure was to show examples to a client.

For instance, a positive scenario could be explained as follow: the U.S. basket and the Asian basket would finish up 70% and 30% respectively; the European basket would close down 20%. In such example, the allocated return would be calculated by applying the relevant weightings – 60% to the U.S. basket return; 30% to the Asian basket return; and 10% to the European basket’s negative performance.

Investors in the notes would get a 49% positive return over the three-year period.

“This is great because you’re not even capped. But the best part is getting the biggest allocation to the best return. I really like the thesis behind this trade,” he said.

Not a worst-of

One “refreshing” aspect of the structure was its contrast with the all-too familiar worst-of products, he said.

“I like it because when you show a worst-of to a client, they always ask: why don’t you pick the best performing asset class? That’s your job! Well this note does it for you. You can tell your client: I now have something that allocates more to the winners and less to the losers.”

As with any structured note, investors would not receive the dividends paid by the components of each index.

“Obviously you don’t get the total return. But the overweight for best performing assets is very favorable,” he said.

“If we see the Euro Stoxx and the FTSE recover and outperform the U.S., you could get a nice performance from this note.”

Less risk

For Balcom the “performance allocator” feature enhances return while lowering risk.

“But you also get the 15% buffer. It makes this note quite defensive,” he said.

He offered an example in which despite the re-weightings, the allocated return at maturity ended up negative. In this scenario, the buffer played its traditional role.

Using a hypothetical 40% decline in the U.S. basket, a 20% loss for the European basket and an Asian basket down 15%, the allocated return for note holders would be minus 19%. With the buffer, investors would only lose 4% of their principal.

“Not only you get more of the best asset class and less of the worst one but if it’s not enough you still have the buffer. It’s a neat concept.”

Excess return

Steve Doucette, financial adviser at Proctor Financial, said the notes offered value as a way to outperform a long-only portfolio based on the same indexes.

“It’s interesting. In this environment you never know what’s going to happen over three years.

Giving the highest allocation to the best return and decreasing the weightings, as the performance declines, is a way to outperform. You’re going to do better than an asset allocator who picked a fixed allocation or is adjusting around it,” he said.

The buffer was another means to generate alpha.

“Your final return after applying the weightings could still be negative. If we have a pullback it’s not impossible to imagine a negative weighted return. But with the 15% buffer you can still outperform the market.”

As good as it gets

Doucette said he understood that technically the structure was not the simple reverse of a worst-of. In a worst-of, the return is linked to only one reference asset, with a 100% exposure to the worst one.

A true “best of” would do the same in reverse, giving investors full allocation to the best-performing underlying, which this note does not do.

“But it’s as close as it gets. I would still call it a best of,” he said.

“The best performing basket is going to be what you get the largest exposure to.”

Doucette agreed that clients would probably find this structure more attractive than a worst-of.

“It’s so much nicer to give clients the greater exposure to the best of and the lower exposure to the worst-of,” he said.

A different trade-off

“Many clients have agreed to using worst-of because it’s a way to potentially outperform when you take that extra risk. You often need a worst-of to get a cap or a buffer that make sense. It’s just a way to expand the parameters of a deal so you can achieve the desired outcome.”

With the HSBC notes, investors were not taking that extra risk. Yet the structure was still appealing.

“You have to wonder...how do they structure it? I guess you’re giving up the leverage and getting the allocation component,” he said.

The trade-off was advantageous in his view.

“Do you really want leverage for that period? It may not do you any good in three years. Instead you’re getting a larger exposure to the best performing index. In this market it kind of makes sense to me,” he said.

HSBC Securities (USA) Inc. is the underwriter.

The notes (Cusip: 40435UCY8) will price on Jan. 31 and settle on Feb. 5.

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