HSBC’s performance allocator notes on U.S., Europe, Asia Pacific resemble best-of

By Emma Trincal

New York, Oct. 25 – HSBC USA Inc.’s 0% performance allocator notes due Oct. 31, 2023 linked to three baskets of regional indexes give advisers a “break” from worst-of products. It is as close as it gets to the rarely seen “best-of” structure, sources said.

The three geographical regions are the United States, Europe and Asia Pacific, according to a 424B2 filing with the Securities and Exchange Commission.

The U.S. basket consists of the S&P 500 index and the Russell 2000 index. The Europe basket consists of the Euro Stoxx 50 index and the FTSE 100 index. The Asia Pacific basket consists of the S&P/ASX 200 index and the Nikkei 225 index.

Each index will have a 50% weight within its respective basket. An allocated return of the baskets will be calculated based on the performance of all three baskets, with the best performing basket to be given a 60% weight, the second best a 30% weight and the worst a 10% weight.

If the allocated return is positive, the payout at maturity will be par plus the gain.

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

Otherwise, investors will lose 1% for each 1% decline of the allocated return beyond 20%.

Adviser’s tool

“It’s actually kind of neat for an asset allocator,” said Steve Doucette, financial adviser at Proctor Financial.

“For the last eight years, most allocators have been struggling with their international equity exposure. It hasn’t been very encouraging.

“Here you get the best of the three regions with whatever these buckets are. You’re not getting the best one but at least the preferred weighted allocation to the best basket. That’s a great tool.

“And they give you a 20% buffer, which is also nice.”

Mapping the notes

One caveat was the Asia Pacific index, he said.

“That’s the one thing I might look at. I don’t have any allocation to Japan and Australia. Do I want to add it? That’s when you have to do your due diligence,” he said.

“Another thing... I’d like to see emerging markets in there.

“They’ve been so beaten up, they’ve got to catch up at some point.

“If they come out screaming out of the gates, you wouldn’t want to miss that especially with the top allocation.”

Aside from those points, Doucette said he liked the concept.

“It’s a lot more exciting than a worst-of and it takes the asset allocation decision off the table.”

Timely

Brady Beals, director of business development at Navian Capital, said he is familiar with the deal.

“It’s out there. We did a little bit of it. It’s a good time to show those products. The divergence between the U.S. and the rest of the world, especially emerging markets, has been quite strong, maybe not just now but in the recent months. It makes those deals attractive for clients,” he said.

“In a worst-of, clients are rooting for convergence. It reduces the risk. With a best of, it’s the opposite.”

The market is turning however as the recent sell-off has elevated correlations between various markets worldwide.

“If we go back to the divergences seen this summer it will be very good,” he said.

Best of dream

Structuring pure best-of options is challenging for issuers, he said. In theory, such deals would be the opposite of a worst-of. Investors would be exposed to the performance of the best of two or several underliers.

“Very difficult to price. You would need such a strong correlation from a pricing perspective; it wouldn’t make a lot of sense for clients.

“Try for instance two biotechnology ETFs. As an investor, there’s not much to gain from that. But in theory, that’s how you could price it.”

Still, the technique used by HSBC in its upcoming note goes in the right direction.

“I like it much better than the Sector Selector deals they did a few years ago,” he said.

Sector Allocator CDs

In 2010, HSBC Bank USA, NA priced a number of 0% sector selector certificates of deposit with minimum return linked to baskets of exchange-traded funds, according to data compiled by Prospect News.

Each year, the best-performing ETF had its return “locked in. The sum of these returns was the basis for the payout at maturity.

“The problem with that was that each year, one of the ETFs was locked-in and removed from the basket. If you held a five-year CD, you didn’t have a point to point exposure to the best ETF. Each year, the best one was locked-in and eliminated.

“With this new deal, you’re getting the highest weighting after the full five years.”

Allocator Notes

Investors are concerned about valuations in the United States and the need to allocate more to international stocks will be an important theme, he reasoned.

Back in 2014 and 2015, HSBC launched a number of “allocation” products providing global equity exposure. Those deals called Allocator Notes followed the same logic: the weightings decreased from best, second best and worst on a scale of 60%, 30% and 10%, according to data compiled by Prospect News.

Today’s notes are different however as they introduce more diversification. This time investors are exposed to three baskets, each of which made of two equally weighted indexes. The old version was simpler, giving direct exposure to three indexes.

HSBC Securities (USA) Inc. is the underwriter.

The notes will price on Friday.

The Cusip number is 40435F3X3.

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