HSBC’s $325,000 leveraged barrier notes on biotech ETF offer insufficient upside, advisers say

By Emma Trincal

New York, Dec. 22 – HSBC USA Inc. priced $325,000 of 0% leveraged contingent buffered enhanced notes due Jan. 5, 2022 linked to the SPDR S&P Biotech ETF, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 150% of any gain in the ETF subject to a maximum return of par plus 20.25%.

If the fund falls by up to 20%, the payout will be par.

Otherwise, investors will lose 1% for each 1% decline of the fund below its initial level.

Giant gains

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, said the structure was not adapted to the distribution of returns of the underlying fund.

“I don’t particularly like the structure,” he said.

“If you’re investing in biotech, you’re looking for large returns. It’s similar to technology in a way.

“Here you’re capping your growth at 20%. That’s not a lot.”

The fund is up 60% for the year. From its low of March, it has jumped 141% after a 36% decline during the first quarter’s bear market.

Big swings

“It’s up a lot more than 20% this year. And when this fund drops it drops a lot more than 20%.

“Since it’s only a barrier, you have unlimited downside.”

Investors will see their return capped if the fund is up only 13% for the year given the 1.5x leverage, he noted.

“I don’t see this ETF trading in a range between -20% and +13%. I really don’t. If you look at the chart, this thing is much more volatile than that,” he said.

The implied volatility of the SPDR S&P Biotech fund is 36.55% versus 22.8% for the S&P 500 index.

“You can’t have a cap on it. When you get exposure to biotech, you’re investing for the upside.

“The barrier protection is not enough. You need a buffer.”

If pricing a structure with uncapped upside and buffered downside is just not possible, Chisholm said he would be more comfortable buying the shares of the ETF outright.

He pointed to large price moves on the chart, for instance a 50% drop in six months from July 2015 to February 2016. On the upside, the fund returned 48.5% in 2013 and close to 45% in 2017.

“These are not small swings. If not, a straight investment in the ETF would be much better.

“I think the structure is mismatched for what you’re looking for in this ETF.”

A different outlook

Jonathan Tiemann, president of Tiemann Investment Advisors, said the notes were designed for investors seeking exposure to the sector at a lower risk.

“You want to invest in biotech but without taking on too much risk,” he said.

“You’re sacrificing a very significant amount of upside potentially, but if there is a modest positive return, you’ll come up well ahead and same thing on the downside –if there is a modest decline, you’ll be protected. If it drops more than 20%, you’ll be in trouble anyway whether you’re long the fund or invested in the note.”

The cap only limits returns in excess of 20.25% but does not eliminate the gains, he noted.

“If the fund is up 30%, you still get 20.25%. You would have been happier with the ETF but it’s not like it’s a terrible thing,” he said.

Investors beat the underlying between the barrier threshold and the upside return needed to generate the cap.

“It very much compresses the range of outcomes,” he said.

“You’re just selling the upside to buy what’s probably an expensive put option on the downside.... expensive because of the volatility,” he said.

There was probably nothing wrong with the pricing of the notes. But investors had to have a range-bound view on this fund.

Bears and bulls would both be disappointed by the barrier and cap respectively, he added.

Asked whether he would consider the notes, Tiemann said: “It’s not a terrible note. If you want exposure to the asset class but play it a little bit safer, it’s fine.

“Personnally I don’t think I would go for it because of the limitation of the upside,” he said.

HSBC Securities (USA) Inc. is the underwriter with J.P. Morgan Securities LLC as agent.

The notes will settle on Wednesday.

The Cusip number is 40438CM24.

The fee is 1%.

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