Barclays, HSBC price longer-dated bull notes on Dow with defensive bias via Merrill

By Emma Trincal

New York, Dec. 4 – BofA Merrill Lynch priced last week $25.66 million on the behalf of Barclays Bank plc and $37.42 million for HSBC USA Inc. of notes linked to the Dow Jones Industrial average, both with longer tenors and solid downside protection, according to two separate 424B2 filings with the Securities and Exchange Commission.

Barclays Bank’s 0% Market Index Target-Term Securities due Nov. 29, 2024 will pay par plus the index return up to a 61.1% cap. At maturity, the principal is fully protected against market declines.

For the HSBC USA’s 0% Leveraged Index Return Notes due Nov. 24, 2023, the upside will be par plus 1.11 times any gain.

Investors will receive par if the index falls by up to 20% and will lose 1% for every 1% decline beyond 20%.

Risk aversion

“For the more conservative investor, the Barclays note makes a lot of sense, especially with days like today when the Dow is down 560 points. In this environment it might be easier to show the full principal protection to a client,” said Tom Balcom, founder of 1650 Wealth Management.

“You lose the dividends. But there is no downside risk.”

He was speaking on Tuesday afternoon, a day marked by a severe sell-off in the markets. The Dow fell more than 500 points at the open and finished the day 800 points lower. Trade concerns around China returned and the inversion of a portion of the Treasury yield curve was interpreted by some as a potential signal of a future recession.

Long tenor

For Balcom, however, six years with the Barclays note or five years with the HSBC product meant long holding periods.

“I don’t like to go five or six years. I prefer to stay short duration because I like to stagger the maturities so that I can reset the terms,” he said.

While having 100% downside protection was “nice” in theory, it might not be needed over such long holding periods.

“This note is really for the risk-averse investor. But it’s always about perception,” he said.

However, one scenario would make the full-principal-protected note particularly useful: if a bear market hit late near the end of the six-year period, perhaps on the fifth year.

“In that scenario you just wouldn’t have enough time to recover from the drawdown,” he said.

“But you can’t tell in advance. Trying to forecast the market six years in a row is very difficult.”

Range bound market

The HSBC note on the other hand was a better fit for a more bullish investor while providing a “robust” downside protection, he noted.

“If the market is flat or rallies, I prefer the buffered one because you are uncapped.

“You still have a 20% buffer, which is generous. If the market is down 25% in five years, you will only lose 5%. “It’s still a very defensive note and you don’t pay too much for that. You still have the leverage and the full upside.”

Protection overkill

Donald McCoy, financial adviser at Planners Financial Services, said that if he had to choose, he would prefer the five-year, uncapped note.

“The chances over a five-year period of losing more than 20% of your principal are pretty low, which is why I’m not sure you want to go one year longer for a 100% protection and a cap plus no leverage,” he said.

Investors in either one of the two notes would have to have moderate expectations of market growth for the period.

Mildly bullish

“If you’re fully bullish, you don’t need any of these products. You just buy the market and get your total return with no downside protection and no cap,” he said.

“But I you don’t expect the market to do much, you’re better off with the leveraged note. It’s good to have no cap even though you may not care because you don’t expect a lot of upside anyway.

“But at least you get a little bit of leverage and you still have that 20% buffer.”

Note versus fund

The leverage factor at 1.11 is indeed modest, he noted. But it reduces the opportunity cost incurred by structured notes holders as they do not receive dividends.

“If you’re long the index, you have the market participation, no downside protection but you get the dividends,” he said.

“With the buffered notes, I’m giving up the dividends but I get the leverage, which will offset some of the lost dividends.”

For McCoy the tradeoff made sense.

“You’re getting the 20% buffer in exchange for the difference between the leverage and the dividends. At least you’re not subject to market volatility. And compared to the other note, you’re not limiting your upside.”

The Barclays notes (Cusip: 06746V776) and the HSBC notes (Cusip: 40436A842) priced on Nov. 29 and will settle on Thursday.

The fee for each is 2.5%.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.