HSBC’s leveraged uncapped notes show fair terms, but four underliers is too many, advisers say

By Emma Trincal

New York, Aug. 20 – HSBC USA Inc.’s 0% market participation securities due Aug. 25, 2023 offer the double benefit of uncapped upside and buffered exposure over a reasonably short period of time. But not every adviser is on board for a worst-of payout consisting of four indexes. Those are: the Dow Jones industrial average, the Russell 2000 index, the Nasdaq-100 index and the S&P 500 index, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 1.55 times any gain of the lesser performing index.

Investors will receive par if the lesser performing index falls by up to 15% and will lose 1% for each 1% decline of the lesser performing index beyond 15%.

Plain-vanilla

Steve Doucette, financial adviser at Proctor Financial, said the notes offer the kind of structure he likes most. But one would have to be bullish to overcome the idea of having exposure to the worst of four indexes.

“It’s a nice simple note – 1.55 times on the upside, uncapped, and a 15% buffer...If you’re bullish, it’s a great opportunity to capture some upside, and if you’re wrong, you still have the buffer.

“I like the risk-reward profile.

“You have an opportunity to outperform on either direction.”

Tough to find

Some bullish advisers have noticed that uncapped index-linked leveraged notes have become harder to find, especially when they also provide a buffer or a barrier, unless the duration of the product is extended often well beyond five years.

“Obviously, the trade-off is having those four different indices,” he said.

“It’s all U.S. and they’re presumably correlated.

“But the real risk you run is that the Nasdaq falls on its face.”

Tech behemoths

The tech-heavy Nasdaq-100 index is up more than 25% year to date despite losing nearly a third of its value during the Feb 19-March 23 bear market earlier this year.

The S&P 500 index, which lost about the same percentage during that period, is now up only 4.7%. Its rise has been largely attributed to the heavy weighting of mega-cap stocks in the technology sector.

“Tech is going through the roof. The way it’s going you hear the same rationalizations as before...This time it’s different...or this is the new normal. But history has proven time and time again that it’s not different. What goes up must come down.

“Just look at Tesla.”

The electric-car manufacturer has seen its stock appreciate in price by more than 376% this year. Just in the past month, the stock has jumped more than 31%.

“Is that sustainable? What about their competitors? Every car manufacturer is chasing them,” he said.

Not so correlated

The coronavirus pandemic has created value for many “stay-at-home” stocks such as Amazon and Netflix. Since bottoming in mid-March, the share price of Amazon has more than doubled.

“We don’t know what’s going to happen with Covid. Are those tech stocks going to blow up? Or are they going to go through the roof if people are forced to stay home again?” he said.

“Meanwhile, small businesses will get hurt if we continue to suppress the economy. That would have a negative impact on the Russell.

“If we have the lockdowns, the Russell can sink but the Nasdaq could do well. Those indices may not be as correlated as they seem to be.”

Trade-off

Doucette still admired the structure.

“I kind of like these nice vanilla notes.

“If you’re bullish, the worst-of on the upside is fine. At least you don’t have a cap. You can catch some outperformance on the upside and on the downside.

“But who knows where the market is going to be in three years? This worst-of exposure with four indices is the concession you have to make to get those great terms. I’m not sure I’d want to go for it.”

Protection first

Matt Medeiros, president and chief executive of the Institute for Wealth Management, was more concerned about protection than upside returns.

“What jumps out at me is that on a three-year and with a worst-of based on four different securities, I don’t think the 15% is rich enough. I would prefer a deeper buffer,” he said.

Worst-of

“I’m not a fan of worst-of portfolios to begin with, and certainly not with four different indices.

“You can’t model the risk. You don’t know what you’re betting on.

“With a single underlying you can run a simulation. With four it becomes infinitely more complex. You have to take into account correlations and many other factors. It’s not very practical when you’re trying to budget your risk.”

Medeiros said the notes offered no appeal.

“Having four different securities and a low buffer are real shortcomings to me. And the benefits I’m getting are not enough to make it interesting,” he said.

To cap or not

Medeiros said he likes to see uncapped notes. This feature was probably one of the best in the structure.

“Fundamentally I’m opposed to having a cap,” he said.

This view, he added, is based on the notion that taking equity risk should be compensated with equity returns.

“I can look at a cap though if there is leverage and if the maximum return is within the range of my return expectations,” he said.

Breaking it up

If he had to “redesign” the product, Medeiros would split the notes into two different products, keeping the same maturity.

“I can see one of the notes linked to the Dow and the Nasdaq, the other to the Russell and the S&P.

“But I would definitely want a 20% buffer.

“If keeping it uncapped requires giving up the leverage, I could look into that.”

HSBC Securities (USA) Inc. is the agent.

The notes priced on Thursday and will settle on Aug. 25.

The Cusip number is 40438CTQ4.

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