HSBC’s barrier participation notes linked to Russell 2000 target bullish yet cautious players

By Emma Trincal

New York, Aug. 4 – HSBC USA Inc.’s 0% barrier market participation notes due Aug. 31, 2018 linked to the Russell 2000 index offer uncapped upside participation with a 25% contingent protection on the downside, a risk-reward profile designed to appeal simultaneously to bulls and risk-averse investors, sources said.

If the index return is greater than zero, the payout at maturity will be par plus at least 100% of the index return. The exact upside participation rate will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by 25% or less and will be fully exposed to the index’s decline if it falls by more than 25%.

Defensive

Tom Balcom, founder of 1650 Wealth Management, said the notes are attractive for skittish investors.

“This is for someone who is more conservative, someone worried about valuations being overstretched. That’s the reason behind this 25% barrier, which is quite big,” he said.

When compared to a long-only equity investment, the only drawback besides credit risk exposure is the loss of dividends, he noted.

“The payout lets the client participate in the upside. You lose the dividends, but there is no cap. It’s for the more risk-averse type of investor. It allows them to have full exposure to the market but some good protection.

“I think any investor having full upside exposure to the index would be quite happy with a 25% downside protection.

“This is for the type of client who comes to see his adviser and says, I need market exposure, but I’m worried that the market is overpriced. Can I get the exposure with protection?

“The client decides to give up the 4% dividends for the protection. If you’re risk-averse, it’s a trade-off that makes a lot of sense.”

Contradictory profile

Donald McCoy, financial adviser at Planners Financial Services, said something in the payout intrigues him.

“Unlike many other notes, this one is very straightforward,” he said.

“In return for giving up the dividend, you get the 25% contingent protection.

“But you wonder what exactly the investor wants to accomplish with the notes.

“This investor doesn’t want to be capped on the upside but is ready to give up 4.3% to get a 25% barrier. Twenty five percent is a big barrier. The odds are in your favor that you’re not going to see the Russell 2000 down 25% from its spot price in three years.

“The person is bullish on the upside with a giant hedge. I’m not sure exactly what that means.”

He concluded that the risk-reward profile of the investor is mixed – very bullish on the upside and conservative on the downside.

The uncapped gains would satisfy a strongly bullish investor.

“If you were only slightly bullish, you would settle for a cap with perhaps some leverage. Clearly it’s a bullish note,” he said.

At the same time, the 25% contingent protection suggests a rather skittish investor whose risk tolerance does not seem to match the bull’s outlook.

“Investors who buy the notes have some sort of a contradictory approach,” he said.

“They’re trying to squeeze all the return they can out of the Russell while paying for that significant downside protection.

“It’s almost the perfect example of someone hedging their bets. I think it will go up a lot, but if I’m wrong I want a lot of protection.

“They pay for the downside with the dividends. Is it a good trade-off? It depends on what the index ends up doing.

“If they’re right, if the index moves up a lot or is down up to 25%, they’re getting it both ways. They made a bullish bet on equities. They were not sure 100% to be right, so they hedged themselves. And they were rewarded with either making money or getting their principal back.

“In this case, the 4.3% no-dividend is not a big price to pay.”

Sideways market

“But if you think, as I do, that returns in equities are going to be compressed, then not getting the dividends can cost you a lot,” he said.

“Say the Russell 2000 over the next three years is up only 5% a year ... almost a third of that is going to be the dividends.

“That’s a lot to pay if the market doesn’t move a lot.

“Obviously, not getting the dividends is less of an issue if the index surges.”

McCoy said it makes sense not to forgo dividends.

“I would be in the cautiously optimistic camp. I don’t expect great returns, but I don’t expect the world to collapse. I’d rather keep the dividends and give up the downside protection.”

Barrier versus buffer

Assuming the notes fit with the bullish-yet-cautious outlook of the investor, the nature of the protection may pose a problem.

“If protection was an issue for me, I would much rather have a buffer ... even a 10% buffer instead of a 25% barrier.

“The 25% protection is big. But with a 10% buffer, regardless of the index decline, everything is pushed to the right on the downside. My losses are just reduced by 10% all the way around.”

HSBC Securities (USA) Inc. is the agent.

The notes (Cusip: 40433B5C8) will price Aug. 26 and settle Aug. 31.

HSBC in the same prospectus announced plans to issue two other three-year barrier market participation notes, one linked to the S&P 500 index with the same 75% barrier (Cusip: 40433B5B0) and the other (Cusip: 40433B5D6) tied to the Euro Stoxx 50 index with a 70% barrier. The one-to-one uncapped exposure to any index gain on the upside is the same for all three products.

© 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.