HSBC’s dual directional trigger PLUS tied to Euro Stoxx 50 offer alternative to long-only play

By Emma Trincal

New York, Oct. 31 – HSBC USA Inc.’s 0% dual directional trigger Performance Leveraged Upside Securities due Dec. 4, 2019 linked to the Euro Stoxx 50 index allow investors to potentially outperform the euro zone benchmark on both sides of the trade. But advisers have different views on the value of the contingent downside protection.

If the index finishes at or above its initial level, the payout at maturity will be par plus double the gain, up to a maximum return of 56%, according to an FWP filing with the Securities and Exchange Commission.

If the index falls but finishes at or above the 80% trigger level, the payout will be par plus the absolute value of the index return.

Otherwise, investors will be fully exposed to any losses.

Mandatory exposure

“I like it,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

“First, anyone who does asset allocation is going to have a non-U.S. component in their portfolio. The bulk of non-U.S. equities is going to be developed countries, and that is going to be overwhelmingly European stocks.

“Since I have to allocate to Europe, I can either buy the index or do a note like this one.

“In this case I would do the note.”

As an alternative to the euro zone benchmark, Kunhardt said that the notes offer return enhancement on both the upside and the downside.

“I get two times leverage on the upside. It’s up to a 56% cap, but this is a very attractive cap,” he said.

The 56% level represents on an annualized compounded basis a 16% cap.

At this level, investors are unlikely to be penalized by the notes in comparison to the index, he said.

Absolute return

“On the downside, I do better with the notes than if I was long the index,” he said.

“With the notes, not only do I have a contingent protection but my protection enhances my performance.

“If I’m down 15%, I’m not down 15%. I’m up 15%.

“It’s good not just from the risk perspective. It also enhances my return.”

European Dow

The “only negative,” he said, is the concentration of the underlying index.

“With the Euro Stoxx you’re really rolling the dice on 50 companies. It’s the European Dow,” he said.

When looking for European stock exposure, Kunhardt said he likes the MSCI EAFE index better. The index tracks the equity performance of developed markets excluding the United States and Canada. It is often used as an alternative to gain exposure to European markets.

“You have 935 companies. It’s massive diversification. And about two-thirds of it is European exposure.”

Credit, fees

Michael Kalscheur, financial adviser of Castle Wealth Advisors, said the payout on the upside is attractive, but he is not comfortable with the risk.

Kalscheur starts his analysis with the cost of a product and the issuer’s creditworthiness.

“The credit is good. We wouldn’t have a problem with HSBC,” he said.

The fees associated with the notes are 2.5% in commissions and 0.5% in structuring fees.

HSBC Securities (USA) Inc. is the agent with Morgan Stanley Wealth Management acting as dealer.

“It’s lending itself more into the brokerage side of the business. ... One percent a year is not a deal-killer, but we would want to have them waive the commission, put it in on the cost and improve the terms for our investors.”

Barrier

Kalscheur’s objections pertain to the risk on the downside despite the absolute return feature.

“It’s a barrier, not a buffer. That’s why the terms are so generous. You’re not looking at a true buffer,” he said.

As part of his analysis, Kalscheur evaluates the market risk based on historical data on the index. For the Euro Stoxx 50, he looked at three-year trailing periods since 1986.

The chances of losing more than 20% based on this analysis represented 21% of the time.

“Having one chance out of five to lose money is significant. And when you lose money, you lose at least 20%, which is a lot,” he said.

“Am I anticipating a 20% decline in three years? No, but boy! This is a dangerous cliff. ...”

He took the example of a 20% index decline at maturity, which would generate a 20% return for investors.

“You’d outperform by 40%. Now if you’re down 21%, you lose 21%. That’s a big difference for just one point,” he said.

“And knowing that I have one chance out of five to see this type of massive loss scenario happen would make me very nervous.”

Buffer, yield

Kalscheur said other alternatives could be considered, for instance a buffer in place of the barrier.

“I could give up the 20% barrier and even the absolute return for a buffer, but what type of buffer would I get?”

He assumed it could be in the neighborhood of 10%.

“That doesn’t help me much because with this index you’re giving up a fairly high amount of yield.”

The Euro Stoxx 50 has a 3.79% yield. Over three years, investors would have to forgo more than 11% in dividends, he noted.

“It doesn’t do me any good. I’m not going to trade 11% worth of dividends for a 10% buffer.”

Not conservative

Finally Kalscheur said the Euro Stoxx 50 is not his favorite underlying in spite of the fact that the index is “well-known” and “easy” to understand.

“It’s only 50 stocks. The textbooks will say 50 is enough, it’s diversified. It’s not. Do you know any mutual fund manager out there who owns 50 stocks?” he said.

Kalscheur explained that most of his clients are risk-averse.

“They buy notes to protect themselves against the downside risk. If they give up a little bit of the upside, they’re OK because they also own actively managed funds and ETFs, which will capture that. What they want is risk mitigation,” he said.

“Having a 20% chance of losing money and not getting the high dividend yield of this index are deal-breakers for me,” he said.

“Normally I would extend the maturity from three to five years to reduce the risk, but it doesn’t help. This index is just as volatile over five years.”

The probability of losing more than 20% since 1986 over a three-year period is 21.3%. It is 21.6% over a five-year rolling period, he said.

“I’ll take a pass.”

The notes will price on Nov. 30 and settle on Dec. 5.

The Cusip number is 40435B361.

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