HSBC’s $2.52 million daily observation barrier absolute return notes on S&P offer flexibility

By Emma Trincal

New York, Aug. 21 – HSBC USA Inc.’s $2.52 million of 0% barrier absolute return market-linked notes with daily barrier observation due Aug. 20, 2025 linked to the S&P 500 index could be used in a variety of ways as a proxy for different asset classes, a financial adviser said.

However, the principal-protected product may not offer as much value as a risk-free asset, argued another adviser.

A barrier event occurs if the closing level of the index is at or above 127.5% of its initial level or below its initial level by more than 20% on any day during the life of the notes, according to a 424B2 filing with the Securities and Exchange Commission.

If a barrier event has occurred, the payout at maturity will be par plus 5%.

If a barrier event has not occurred, the payout will be par plus the absolute value of the index return, subject to a floor of par plus 5%.

High-yield replacement

Carl Kunhardt, wealth adviser at Quest Capital Management, said he would allocate the notes to his fixed-income portfolio.

“I like it. I would use it as a high-yield substitute in my bond portfolio,” he said.

He explained why.

“I have principal-protection against a market decline, so this is just like a bond. Now it leaves me with credit risk exposure and in this case, I’m exposed to HSBC’s credit. But HSBC’s credit is investment-grade, so I’m taking less risk than with a high-yield position,” he said.

HSBC USA Inc. has an A- rating from S&P Global Ratings.

Market-linked

Kunhardt did not rule out the possibility of participating in the stock market within the range defined by the upper and lower barriers.

“This note also gives me exposure to equities if I don’t breach any of the barriers,” he said.

“If that’s the case, I don’t mind the 27.5% cap on the upside because I don’t really expect the S&P to be higher than that in two years.”

A market decline in excess of 20% would make the note less risky than a high-yield security, he noted, pointing to the risk of default associated with high-yield bonds.

“If the S&P breaches the -20% barrier, I’m only getting 5% but I’m taking less risk than with a high-yield position. If the market is down 20% or more, what’s the business climate like on a company with sketchy credit?” he said.

For Kunhardt, the notes offered ample flexibility.

Flexible allocation

“The beauty of structured notes – and that’s also what makes them problematic sometimes – is that they’re not an asset class. But that’s the magic too... You can fit them wherever you want in your portfolio,” he said.

For Kunhardt, using the HSBC-issued note as a proxy for a non-investment grade position would have one clear benefit: reducing credit risk.

Kunhardt would not use the notes as a cash substitute despite the principal protection and guaranteed 5% return.

“If you want a liquid, risk free asset, you don’t want to use that. You would be using Treasuries or even money market funds,” he said.

But what made the notes really attractive was the possibility of earning much more than a bond.

The range between -20% and +27% was “wide enough” to offer the opportunity of getting equity returns, he added.

“You can use it in your fixed-income allocation and still have equity opportunity,” he said.

Multiple conversations

Because of the fixed return, principal-protection and potential market participation, advisers may be able to get the attention of a variety of clients.

“It’s a flexible investment. You as an adviser can direct the conversation in different ways,” he said.

“If you’re talking to a conservative investor, you can emphasize the fact that they’ll get their money back plus 5%. But you have to mention the risk of underperforming Treasuries.

“If you’re talking to a more risk-tolerant investor, you can point to the possible equity gains. If the market is down 19%, you will turn a minus into a plus and get +19%. You do have a 27% upside cap but you’re being compensated for that with the principal protection.

“You can really market this product to many different types of clients. I like it.”

No match for Treasuries

Jerry Verseput, president of Veripax Wealth Management, assumed that investors in the notes would pursue the goal of safety and liquidity.

“You are getting your principal plus 5% after two years. That’s 2.5% a year. If you need the money in two years, I would compare it to a Treasury,” he said.

“But in that case, why wouldn’t you buy a Treasury? By using this note, you’re cutting your return in half.”

A two-year Treasury yields 5%.

If investors aimed at having access to their money in two years without loss of principal and with the highest return, then trying to gain exposure to the stock market should not be part of the decision.

“Taking the risk of a barrier breach will cut your guaranteed return from 5% a year to 2.5% a year.

“The odds of success are limited. This is too narrow a window to benefit from the market exposure and the daily observation adds a huge amount of risk,” he said.

Not a pure play

The notes would not express directional market bets.

“If you’re bearish, you wouldn’t want to use it. If the market dropped more than 20% you would only get 5%. Why would you do that? If you’re bullish, the S&P can easily go up more than 27.5% in two years. Why would you cap yourself?” he said.

The prospect of making more than the guaranteed return was a risk, which conservative investors should avoid.

“I understand that you could make more than the two-year Treasury if you get the absolute return. But you have no guarantee to get it. In fact, chances are that you won’t.

“This note seems more like a marketing gimmick to me than an investment,” he said.

“If you need your money in two years, you’re better off getting a 10% return in two years instead of taking the risk of earning half of it,” he said.

UBS Financial Services Inc. and HSBC Securities (USA) Inc. are the agents.

The notes settled on Friday.

The Cusip number is 40447AJR6.

The fee is 2%.

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