HSBC offers pair of leveraged notes on the Russell 2000 index to fit rangebound market views

By Emma Trincal

New York, Dec. 1 – HSBC recently priced two leveraged capped notes offering exposure to the U.S. small-cap equity market with slight differences in tenors, protection, cap levels and leverage, allowing advisers to express their respective preference.

Two years, buffered

HSBC USA Inc. in the first deal priced $19.73 million of two-year Leveraged Index Return Notes linked to the Russell 2000 index.

If the index return is positive, the payout at maturity will be par of $10 plus 200% of the index return, subject to a maximum payout of par plus 30.8%.

On an annualized compounded basis, 30.8% represents a cap of 14.4%.

Investors will receive par if the index declines by 10% or less and will lose 1% for every 1% that it declines beyond 10%.

14-month, 3x

The second issue was shorter and lacked any downside protection. But as a tradeoff, investors enjoyed a higher cap on an annualized basis and more upside leverage.

HSBC USA priced $23.75 million of 14-month Accelerated Return Notes linked to the same index, according to a separate 424B2 filing with the SEC.

The payout at maturity will be par of $10 plus triple any index gain, up to a maximum payout of par plus 25.21%. Based on the 14-month maturity and 3x leverage, the cap represents 21.3% per year on a compounded basis.

Low expectations

The underlying index only needs to rise by approximately 7% a year to bring the return of both notes to their maximum levels, noted Steve Doucette, financial adviser at Proctor. That’s because the note with the highest cap is also the longest in duration, he added.

“You sort of have a rangebound view of the market whether you buy the two-year or the 14-month, “he said.

“If you’re a little bearish over the next two years, you want that buffer.”

Cap, tenor

Without being bearish, Doucette said he liked having the 10% hard protection.

“I wouldn’t touch it. But I would be looking to raise the cap on the two-year for a little bit less leverage,” he said.

On an annualized basis, the 14-month note offered a higher cap of 21.3% versus a 14.4% cap on the two-year.

But one could not make a decision solely based on the cap level.

“With time comes the hard part. No one has any idea where the market is going to be in 14 months. If there’s a recession coming, will it be over by then? I have no confidence in that 14-month term.

“My philosophy is that the only way to reduce volatility out of this market is to add time,” he said.

He said he preferred the two-year note for that very reason.

Including a buffer into the 14-month note would be impossible, he noted, even if the leverage factor was substantially reduced.

Outside the band

Despite his slight preference for the two-year note (assuming the cap could be raised), Doucette was not showing any strong interest in either deal.

“I still don’t like having a cap in this market. I don’t know how much leverage I should give up in order to get a decent cap. And what would be a decent cap anyway? If the market comes roaring back, you’ll be sorry to limit your upside,” he said.

He concluded that the notes were not designed for bulls. Instead, they were intended for investors having a rangebound view of the market.

“That would not be for me. I don’t like to limit myself on the upper range,” he said.

Irreplaceable buffer

Matt Medeiros, president and chief executive of the Institute for Wealth Management, was more inclined to choose the two-year buffered note.

When examining a structured note, this adviser said he always compares the benefit of a note with the purchase of the underlying outright.

“The 14-month one has no downside protection. That’s not particularly attractive for us since we see buffers as one of the most valuable features of structured notes versus a long-only position,” he said.

“The only advantage of the shorter note is the 3x leverage. There is something to be said about high leverage. It’s definitely attractive.”

Leverage advantage

The benefit of leverage in a note was due to its asymmetrical quality.

“To have a three-to-one exposure on the upside and one -to-one on the downside is very nice. You can’t get that with an ETF. Any three-times levered ETF will lever up your return both on the up and on the down.”

But the competitive advantage of leverage was not enough to incite this adviser to buy the notes.

“I would rather not even take the credit risk and if I was bullish on the Russell, do it outside of a note, take a long position and avoid the cap,” he said.

If he had to choose, this adviser would select the two-year product.

“It’s a little bit better, mainly because you do have the buffer. For a two-year, a 10% buffer is adequate. Of course, you always want more protection, but you won’t get it on such a short maturity,” he said.

BofA Securities, Inc. is the agent for both offerings.

Both issues settled on Wednesday and carried a 1.75% fee.

The Cusip number for the 14-month Accelerated Return Notes is 40441B876.

The Cusip number for the two-year product is 40441B702.

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