HSBC’s 8.7% autocallable yield notes on S&P 500, Russell show excess risk for limited gain

By Emma Trincal

New York, June 23 – HSBC USA Inc.’s 8.7% autocallable yield notes due Oct. 1, 2021 linked to the least performing of the S&P 500 index and the Russell 2000 index offer a fixed coupon over a short maturity with a six-month call protection. But advisers said the risk-adjusted return of the notes was disappointing, pointing to the coupon size and the market risk exacerbated by elevated valuations.

Interest is paid monthly, according to an FWP filing with the Securities and Exchange Commission.

The notes will be called at par if each index closes at or above its initial level on any monthly call observation date, starting Dec. 29.

The payout at maturity will be par unless any index finishes below its barrier level, 70% of its initial level, in which case investors will be fully exposed to the worst-performing index.

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, said the notes did not match his market outlook.

Barrier protection

“I don’t find it appealing at all,” he said.

“Your upside is not even 8.70% because the notes are likely to be called early.

“You have a 30% protection which normally should be decent but not necessarily at those levels.

“If you anticipate the U.S. market to be flat, then it’s a good way to play it.

“But it doesn’t line up with my expectations of where the market could be in 15 months.”

For this adviser, the S&P, which plummeted by more than 35% during the recent crash is not immune from another drop of similar magnitude.

The heavy sell-off from Feb. 19 to March 23 was followed by a strong rally leaving the market to wonder whether it is a so-called bear rally or the return of the bull market.

“The S&P is close to its high now. The Russell is a little bit lower,” he said.

“If you look at market valuations, the 30% protection may not be all that much,” he said.

Worst of identified

Chisholm said he would be more bullish on the S&P 500 index than on the Russell 2000.

“I don’t like worst of in general because you don’t know what your exposure is.

“But in that case, I’m more bullish on the S&P. I think the Russell is the most likely to be the worst of.”

The technology-heavy S&P 500 index has driven the market recovery due to the exceptional performance of a few stocks, the FANG stocks especially, he added.

The FANG stocks include Facebook, Amazon, Netflix, and Alphabet.

“The performance of the S&P would hold up well in a downturn because tech stocks can boost up prices. It’s a different story with the Russell. Smaller companies tend to be less resilient in a recession.”

Risk-reward

Steven Foldes, vice-chairman at Evensky & Katz / Foldes Financial Wealth Management, was also concerned about the market’s valuations along with the uncertainty fueling bouts of volatility.

“I don’t like the risk-reward of the notes. I like the creditworthiness of HSBC. But not the structure,” he said.

“There’s also the fee...0.75% fee is a little bit on the high side.

“But what I really don’t like is the return you get for the risk you’re taking.

“Your reward of 75 basis points a month is very modest.”

Foldes was also critical of the tax consequences of the payout.

“You’re getting the income monthly. So, it’s treated as ordinary income, not long-term capital gains.

“You’re also giving up dividends.”

Another objection was the risk of a call on the first observation date in six months, giving investors a return of only 4.35%.

“That’s a very modest income and for a significant amount of risk.”

Valuations

He pointed to the surging stock prices since the March bottom. Over approximately the past three months, the S&P has regained 43% and the Russell, almost 50%.

“Valuations are dangerously high.

“The big risk is you could break the barrier quite easily from those levels.”

Uncertainty around the health crisis is also a concern.

Uncertainty

“We’re still in the midst of the Covid-19 pandemic and we have yet to have a vaccine. Hopefully, we will find one, but the market is sensitive to Covid-19 developments and headlines. It could tumble again,” he said.

If the barrier is breached, investors will lose no less than 30% and could in theory lose their entire principal.

“Try to explain to a client that for an incremental income, for 75 basis points a month, they could lose 30% or more.

“Even if the odds of losing money are low, it’s still not attractive.

“Tell a client they have, for example, a 75% likelihood to make 4.35% in six months with a 10%, 15% or 20% chance of losing 30%. I’m just guessing, but you see the point. I don’t like the odds.”

HSBC Securities (USA) Inc. is the agent.

The notes will price on June 26.

The Cusip number is 40438CMR9.

© 2015 Prospect News.
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