HSBC’s performance allocator notes on baskets of indexes offer enhanced global exposure

By Emma Trincal

New York, Dec. 5 – HSBC USA Inc. plans to price 0% performance allocator notes due Dec. 27, 2024 linked to three regional baskets of indexes, according to an FWP filing with the Securities and Exchange Commission.

The U.S. region basket consists of the S&P 500 index and the Russell 2000 index. 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 55% of the best basket return, 30% of the second-best basket return and 15% 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%.

Best-of exposure

“I’m a big fan of those allocation notes,” said Steve Doucette, financial adviser at Proctor Financial.

“I wish we’d see them more often. So far it’s been mostly HSBC coming up with those things.”

The allocation provides a “best-of” exposure, he said, contrasting with the profusion of worst-of products seen in the market.

“It’s a great way to maintain a globally diversified portfolio and boost the return.

“You’re coming back with whichever the best asset class is with a higher weighting.”

International value

The combination of the three baskets offered a global allocation exposure. Doucette said that from a valuation standpoint, the European and Asia-Pacific baskets were promising.

“International stocks haven’t done so well in the past 10 years if you compare them with U.S. stocks. This trend will reverse. There’s such a huge discrepancy of returns between Europe and Asia versus the U.S. It’s only a matter of time.

“Australia’s stock market hasn’t been particularly impressive and we haven’t seen any significant bullish trend in Europe in the past 10 years at least,” he added.

The average annual return over the past 10 years has been less than 5% for the S&P/ASX 200 index and less than 3% for the Euro Stoxx 50.

“Five years out...we don’t know what can happen. The U.S. can get all the way down and the others might take over... or maybe not. That’s why you don’t want to give up the U.S. exposure,” he said.

Extra diversification

“The beauty of this note is that you can’t get more than 15% allocated to the worst basket,” he said.

The only thing Doucette may have changed would be adding emerging markets into the mix.

“If you swap out Japan and put an emerging component, it would be even more interesting.”

The 15% buffer was another enticing aspect of the deal.

“If the market is down 25%, you’re only down 10%. It’s always good to have something that insures the portfolio a little bit against losses,” he said.

Portfolio tool

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he liked the notes as an asset allocation tool.

“It’s an interesting note. I would consider it as a basic asset allocation type of instrument,” he said.

“On a five-year timeframe, this offers a very sound approach to a core asset allocation strategy.”

Investors get exposure to developed markets and the United States.

“It is diversified and the optimized weightings provide an additional safety net,” he said.

“However, the 15% buffer over a five-year period on these indices is a little bit lower than what I would have expected.”

All down

Just because the notes provide an allocation that minimizes the worst-performing basket and maximizes the best one with the second-best in between, does not necessarily mean the final allocated return will not end up negative.

“You have to consider all scenarios,” he said.

The prospectus offered an extreme example in which all baskets finished down.

The performance of the U.S. basket in the example was minus 20%; the European was minus 30%; and the Asia-Pacific was minus 50%.

The allocated returns per basket when applying the 55%, 30% and 15% respective weightings were then minus 11%, minus 9% and minus 7.5%, respectively. Overall, the underlying return was the sum of the three, or minus 27.5%. Investors’ investments would not decline by the same percentage thanks to the 15% buffer. Yet they would end up with a 12.5% loss.

Buffer

“It’s an excellent strategy but we’ve been in a bull market for a long time. The allocator mitigates risk but you could still use a little bit more protection.

“The fact that it’s a five-year works to your advantage because if we go through a bear market, we still have time left for recovery.

“I like the notes as a tool to create a core asset allocation. But I wouldn’t want to do it naked. I would want to have more downside protection than 15%,” he said.

HSBC Securities (USA) Inc. is the underwriter.

The notes will price on Dec. 19.

The Cusip number is 40435UP81.

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