HSBC’s performance allocator notes linked to three baskets of indexes seen as valuable tool

By Emma Trincal

New York, July 22 – HSBC USA Inc.’s 0% performance allocator notes due Aug. 5, 2022 linked to three baskets of indexes appeared attractive to advisers who saw in this product the combination of a unique allocation tool and a way to boost performance.

The U.S. region basket consists of the S&P 500 index and the Russell 2000 index, according to an FWP filing with the Securities and Exchange Commission. The European region basket consists of the Euro Stoxx 50 index and the FTSE 100 index. The Asia Pacific region basket consists of the S&P/ASX 200 index and the Nikkei 225 index. Each index has a 50% weight in its respective basket.

The allocated return will be 50% of the best basket return, 30% of the second best basket return and 20% of the lowest basket return.

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

If the allocated return is less than or equal to zero but greater than or equal to negative 15%, the payout will be par.

If the allocated return is less than negative 15%, investors will lose 1% for every 1% that the allocated return is less than negative 15%.

Credit

One adviser said not only the payout but also the creditworthiness of the issuer were surprisingly attractive.

“HSBC has a very high credit rating,” said Steven Foldes, vice-chairman at Evensky & Katz/Foldes Financial Wealth Management.

The five-year credit default swap rate for the British bank is 32 basis points, according to Markit. It is slightly lower than JPMorgan, which is the U.S. bank with the tightest spreads at 37 bps. In comparison, Morgan Stanley and Goldman Sachs show spreads of 55 bps and 60 bps, respectively.

Automatic allocation

Foldes said the payout structure was attractive, especially for an international portfolio.

“I haven’t seen this type of allocation note before. But I certainly like the idea of benefiting from a higher weighted return on the best of the three baskets. That way, you don’t have to make a bet on which will be the best one,” he said.

The prospectus offered examples of the payout.

In one scenario, all the baskets are up. The U.S. basket has a 70% return, the European basket has a 20% return, and the Asia Pacific basket has a 30% return. Using the allocation formula at maturity, the final allocated return would be (70% x 50%) + (20% x 20%) + (30% x 30%), or 35% + 4% + 9%=48%.

“It’s relatively straightforward the way they do this,” he said.

Another example with all three indexes falling at maturity illustrated that performance would be better than with an equally weighted portfolio.

“If you want a global equity allocation and if you understand the importance of investing in a global market, as you should, this gives you a pretty good global allocation or at least an exposure to international developed markets since they don’t include China and the emerging markets.

“It takes away the need to decide what should be your allocation. You know you’ll have the highest allocation to the best-performing underlying. That’s very compelling.”

Buffer in question

Despite those benefits, Foldes pointed to some possible improvements.

“For a three-year term, the buffer becomes less compelling. Anything after two years reduces the chances of getting a negative return at maturity from a probability standpoint,” he said.

“And given the high allocation to the best-performing basket, it’s even less relevant to have a 15% buffer in this note.

“It would only make sense for a more conservative client, someone who is concerned about the overall market.

“In general, we would much rather have more opportunity on the upside, whether it be leverage or, conversely, an even higher allocation to the best-performing basket in order to increase the return.”

Dividends

The typical requirement to forego dividends may represent a greater sacrifice with this note compared to a product linked solely to the S&P 500, he also noted.

“My guess is that you’re giving up close to 3% in dividends given some of the high-yielding indices included in the baskets,” he noted.

The Euro Stoxx 50 yields 2.85%, or about 1 percentage point more than the S&P 500. The yield on the FTSE 100 index is 4.4%.

“But that’s part of the give up. Overall, it’s an attractive note with a reasonably compelling profile.”

Low fee

Jerrod Dawson, director of investment research at Quest Capital Management, said he was even surprised about how the issuer would be able to price the deal.

“It seems like a great structure with low fees,” he said.

“You’re going to do better than with an equally weighted basket. The only trade-off is the usual liquidity and dividends. But it’s still very attractive.”

The fee is 1.2%, or 40 bps per annum, according to the prospectus.

Buy and hold

“You get a diversified global equity portfolio most people should have,” Dawson said.

“Unless you are a market-timer and hope to get out of the market on time when it’s selling off, it’s a nice way to allocate.

“We are not market-timers. If we were, we would have got out of the market a year ago. It was already expensive then. If we had, we would have missed this year’s rally.

“It looks like a very valuable investment tool ... better than most notes I’ve seen.”

HSBC Securities (USA) Inc. is the underwriter.

The notes will price July 31.

The Cusip number is 40435URF3.

© 2015 Prospect News.
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