HSBC’s lookback securities linked to index basket bring diversification, allocation challenge

By Emma Trincal

New York, Aug. 8 – HSBC USA Inc.’s 0% buffered lookback allocator securities due Aug. 19, 2019 linked to a basket of three indexes may provide attractive returns given their unusual structure, which allocates more to the best-performing indexes, buysiders said.

However, the automatic allocation, which is not known until maturity, makes the traditional asset allocation process more difficult to implement for advisers, one buysider said.

The basket consists of the Russell 2000 index, the S&P 500 index and the Euro Stoxx 50 index. The allocation of each basket component is based on its performance: 40% for the basket component with the best index return, 35% for the basket component with the second-best index return and 25% for the basket component with the lowest index return, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par plus any basket gain. Investors will receive par if the basket falls by up to 10% and will lose 1% for each 1% decline beyond 10%.

Diversification

“It seems like a pretty straightforward deal. You get a diversified basket and a buffer,” said Jerrod Dawson, director of investment research at Quest Capital Management.

The dynamic allocation based on the final performance of each basket component is unusual, he noted.

“I’ve never seen this, although I have heard of it. It’s definitely a compelling aspect of the product.

“Getting the greatest weighting on the best index return and the smallest one on the worst return is a big plus. But the buffer is also a nice feature. I like it.”

The notes are not inexpensive, however, he noted.

The fee is 3%, according to the prospectus.

Equity bucket

“You have the diversification aspect, the allocation based on returns and the insurance against losses with a 10% buffer. I guess you need all these incremental positives to justify the 1% fee,” he said, referring to the annualized fee based on the three-year tenor and fee amount.

Dawson said he likes the international diversification of the underlying with the mix of two U.S. indexes and the widely recognized European benchmark.

The adviser said he would allocate the notes to the equity bucket without knowing the breakdown since the final weightings are determined at the end of the term.

“I wouldn’t allocate it to alternative investments since it’s highly correlated to stocks. It would go to a stock portfolio for a smaller account. It’s a product tailored for someone who wants to get immediate diversification,” he said.

Among the clients who may benefit from the securities, Dawson mentioned investors who “worry” about market declines.

“For clients who need the equity exposure and the growth to meet their financial goals but who are also more risk-sensitive, this note, with its 10% buffer, can provide a little bit of an insurance policy.”

Human touch

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, said the concept behind the notes is attractive. But ironically, the “lookback allocator” in practice would not be a good fit for an adviser dedicated to asset allocation.

“If somebody is investing in this just for the idea, if it’s sold to a client who wants it, that’s fine,” he said.

“But a lot of people focus on allocation. If you have a floating allocation – which you do have with this note since the weightings are based on performance – it makes it harder to allocate appropriately because you don’t know in advance what your final allocation is going to be. You only know that at the end.”

Like most advisers, Chisholm says he uses a core allocation model, which he periodically adjusts based on his own views of the market and the changing economic environment.

“Everybody has their own opinion. You have to put some thought into what makes sense. The note is not really compatible with this approach. Are you going to put this in large-cap, small-cap, U.S., Europe? You can’t tell,” he said.

Beta with no bucket

Some portfolios managers use the alternative investment bucket for what does not belong to any traditional asset class.

“That wouldn’t be a good idea,” he said.

“This is not alternative investments. It’s not a short strategy, a hedge or real estate. It’s three indexes.”

The fee is also a drawback.

“It’s a little bit rich from my perspective. You’re paying 3%, and you’re not getting the dividends.”

The buffer offsets some of those disadvantages but only partially.

“Ten percent is fine. It’s a nice protection. But it doesn’t make up for the lack of dividends and the cost.”

HSBC Securities (USA) Inc. is the agent. Morgan Stanley Wealth Management distributes the notes.

The notes will price on Aug. 12 and settle on Aug. 17.

The Cusip number is 40434V228.

© 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.