HSBC’s performance allocator notes on baskets of indexes to remove guesswork for advisers

By Emma Trincal

New York, Sept. 24 – HSBC USA Inc.’s 0% performance allocator notes due Sept. 30, 2024 linked to three baskets of indexes allow advisers to automatically optimize their allocation in global equity, but an adviser was skeptical about the choice of the underlying baskets as well as the length of the investment.

Each of the three baskets represents a region and includes two indexes of an equal weight, according to an FWP filing with the Securities and Exchange Commission.

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

The notes are tied to the allocated return. The allocated return will be 55% of the best basket return, 30% of the second-best basket return and 15% of the lowest basket return.

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

If the allocated return is less than or equal to zero but greater than or equal to negative 15%, the payout will be par.

If the allocated return is less than negative 15%, investors will lose 1% for every 1% that the allocated return is less than negative 15%.

A win-win

Tom Balcom, founder of 1650 Wealth Management, said he wished he could see more “allocator” structures such as this one.

“It’s a win-win,” he said.

“You obviously want to have global equity exposure. And you’re getting the highest allocation to the best-performing region. The structure does that for you. You don’t have to guess anything. You’re allowing the structure to overweight the best-performing one and underweight the worst-performing one, with the second-best in between.”

What was really appealing for this adviser was the capacity for the notes to “look back” at maturity and allocate accordingly in decreasing order from best to worst-performer.

“Investors always say: asset allocation is your job. You’re supposed to do it right for me. Well in this case, you know the allocation will be optimized. The structure is designed for that. It’s great for the clients and it’s great for the advisers,” he said.

Statements, performance

Perhaps one less attractive feature was the tenor.

“Five years is a long time,” he said.

“When clients read their first statements, they see the cost of the note right there. The pricing on the note may be down and the adviser has to remind them that the notes have to be held until maturity. You have a lot of explaining to do, and it can be complicated,” he said.

On the other hand, the five-year tenor may be advantageous from an investment’s standpoint.

“Europe has been really slow and may have time to rebound. In general, if we go into a recession, the markets should have enough time to recover.”

Five years

Another adviser was less positive about the notes.

“It seems like complexity for complexity’s sake,” said Jonathan Tiemann, president of Tiemann Investment Advisors.

As with all structured notes, investors participate in the index price returns only, he noted.

“You’ve got to pay for the advantages, or the options, with the dividends. So you’re giving up dividends, liquidity, and you get the credit exposure. Nothing unusual here, except that it’s a five-year. Five years is a long time when you don’t get paid dividends, have limited liquidity and are exposed to the issuer’s credit,” he said.

Cheap buffer

This adviser was not even upbeat about the 15% buffer.

“The buffer is not as valuable as it seems because of the best-of structure. It’s not that it may not come into play. You could have the best basket moderately up and the lowest one deeply negative,” he said.

Still, overweighting the best-performer and minimizing the impact of the worst basket were risk-mitigation tools that reduced the odds of a steep decline, he said.

“You really don’t need it, especially after five years,” he added.

“I bet it was almost free for them to price it.”

Odd pairs

The structure of the performance allocator, which gives automatically a 55%, 30% and 15% weighting to the best, second-best and lowest performing basket, may “seem attractive,” he said.

But this adviser was not convinced that the index pairs included in each regional basket were his favorite picks nor that having only two components per basket was sufficient.

“Those indices look like they’ve almost been picked at random,” he said.

“I’m not sure I would actually use any of these combinations.”

He offered more details.

“By putting 50% in the S&P 500 and 50% in the Russell 2000, you way overweight to small-caps relative to the market,” he said.

U.K., Australia

“Having an equal combination of the Euro Stoxx and the U.K. seems odd even though they complement each other since the U.K. is not in the euro zone. But do you really need to have 50% in the U.K. with Brexit?

“The Australian S&P/ASX 200 index is much smaller compared to the Nikkei. This is an odd combination too.

“You’ll end up with a peculiar portfolio. I’m not sure where I would plug this in my overall allocation,” he said.

For Tiemann, the use of a global equity fund would be much more attractive.

“You could have exposure to total returns and get something fully liquid with no credit risk. That to me is more important than re-arranging the weightings of odd baskets.”

HSBC Securities (USA) Inc. is the underwriter.

The notes will price on Wednesday.

The Cusip number is 40435UWE0.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.