HSBC’s $3.17 million autocall buffered notes on Russell, EAFE to shine in a lukewarm market

By Emma Trincal

Buffalo, N.Y., Aug. 24 – HSBC USA Inc.’s $3.17 million of 0% autocallable buffered notes with step-up premium due Aug. 21, 2023 linked to the Russell 2000 index and the iShares MSCI EAFE ETF could generate excess return in a muted market, advisers said. They pointed to the benefit of having a short-dated note with a deep buffer. However, such setup involves some risk, the most obvious one being the weak correlation between the underlying assets, they noted.

The notes will be called at par plus an annualized 10% call premium if each underlier closes at or above the initial level on any semiannual call observation date, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called, the payout will be par unless either underlier falls below 80% of its initial level, in which case investors will lose 1.25% for every 1% decline of the worst performer beyond 20%.

Sideways

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, said the notes are adapted to a specific type of market.

“It’s an interesting note if those markets move in a range. As long as we don’t have a big sell-off, it seems like a reasonable play,” he said.

“Small caps are trading a little bit in a range. They should start to break out as long as the market is higher.

“The EAFE has also been in a range. It’s been climbing a little recently.

“There are some opportunities there. I don’t expect a huge upside for the EAFE, nor do I expect a huge upside for U.S. small-cap.”

The range of outperformance would go from minus 20% to plus 10%, he said, a reasonably wide window, but one that requires no big price moves in either direction, which is hard to predict.

“So much depends on the Fed’s next move,” he said.

“Getting 5% after six months is not bad. If you get called away, so be it.”

Holding up

Another interesting aspect of the structure was the large buffer over a short period of time, he noted.

“The 20% buffer is OK. I like buffers better than barriers. A 20% decline would bring the Russell back to the 2018 levels. I think it would hold up reasonably well,” he said.

The EAFE fund, which for about 60% consists of European stocks, would also “hold up well.”

“I’m not too worried about Europe on the downside compared to the Russell. Europe is not as exciting. It doesn’t go up as much; it doesn’t go down as much.”

Drawback

Chisholm’s main objection was the worst-of payout.

“I’m not sure I would go for it simply because worst-of are complex and difficult to explain. People are not very excited about that type of payoff,” he said.

“But the note is OK.”

Geared buffer

Jonathan Tiemann, president of Tiemann Investment Advisors, said he liked the buffer.

“It seems like it’s well-priced because you do have that protection on the downside,” he said.

“A 20% buffer is quite good for a two-year note,” he said.

Although the buffer is geared, investors are still better off with it than they would be with a barrier, he said.

He gave the example of a 50% decline in the underlying. With an 80% barrier, investors would lose 50% of their investment while the loss would be limited to 37.5% in the notes.

Tradeoff

“Part of what makes the buffer possible is the worst-of. And those two can be quite different from one another,” he said.

The iShares MSCI EAFE ETF tracks large-cap stocks of developed countries excluding North America.

“There’s not much in common between non-U.S. large-cap stocks and U.S. small-cap. So, you do take some correlation risk,” he said.

In addition, investors need to give up some of the upside in order to make the pricing of the buffer possible.

“Your 10% premium is a cap. It’s not a bad cap. But if there’s a big rally and the index is up 12% in six months, you’re called at 5%,” he said.

Allocation

The two underlying asset classes offered the advantage of being commonly used in most asset allocations.

“The notes would find their place in any diversified portfolio,” he said.

“The question is: would you be better off holding this or holding long 50/50 of the Russell and the EAFE?”

Again, the answer depended on one’s outlook.

“You wouldn’t want to be in the notes if you were wildly bullish. But if the performance is somewhat muted, you’re better off,” he said.

“So, for investors who want exposure to those two areas but expect lukewarm returns, you may want to do something like this I suppose.”

Callable, short

Tiemann said structured notes force investors to give up some liquidity, something they need to be compensated for.

In this case, this concern did not take center stage.

“It’s only two years. And you can get called three times before maturity. So, it’s not so bad.

“I don’t love it. But it’s not bad, which for me is pretty good,” he said.

HSBC Securities (USA) Inc. is the agent.

The notes settled on Friday.

The fee is 0.05%.

The Cusip is 40439JJX4.

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