HSBC’s buffered AMPS on SPDR S&P Biotech ETF require expertise, stomach for risk, advisers say

By Emma Trincal

New York, Nov. 9 – HSBC USA Inc.’s 0% buffered accelerated market participation securities due Nov. 24, 2023 linked to the SPDR S&P biotech ETF represent too much of a narrow sector bet, advisers said, noting the high volatility of the sector currently intensified as the race for a Covid-19 vaccine is on.

If the fund return is positive, the payout at maturity will be par plus 1.5 times the fund gain, subject to a maximum return of at least par plus 29.90% to be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the fund falls by 15% or less and will lose 1% for every 1% decline beyond the 15% buffer.

The ETF includes 141 health care stocks and carries no dividend. At 35%, its implied volatility is high compared to the S&P 500 index, which shows a 23% volatility.

Part of the appeal of the fund is the presence of “Covid” stocks in the portfolio such as Moderna Inc. and Novavax Inc., both vaccine developers. Other constituents, such as Regeneron Pharmaceuticals and Gilead Sciences Inc., are manufacturers of Covid-19 treatments.

Well structured

Carl Kunhardt, wealth adviser at Quest Capital Management, said the structure of the notes fits his style.

“Structurally, there’s not much of anything I don’t like,” he said.

“However, given the fact that it’s a very volatile fund, the 30% cap seems kind of low. It’s probably that low because they need to pay for that 15% buffer.

“Regardless, structurally I don’t dislike the note.”

In fact, Kunhardt is always on the lookout for “plain-vanilla” notes of this kind.

“These are the kinds of notes I like. They’re simple, easy to understand. I don’t need to take half a day to do my due diligence on them,” he said.

The underlying fund was more problematic.

Know your limitations

“Each time you’re buying a structured note, you’re not investing that much in the actual security, in the investment vehicle,” he said.

“You’re making a call on the underlying.”

The notes are not tied to a broad index such as the S&P 500 index or the Russell 2000, but to a particular sector of the S&P, which represented an obstacle.

“I prefer broader diversification. Sector investing is limited. It’s not a large part of the market. When you consider a biotech fund, you’re making an investment judgment on that sector, which implies you kind of have some knowledge,” he said.

“Remember Clint Eastwood’s quote? ‘Men must know their limitations.’

“To invest in this, you have to have expertise in the sector, some sort of feel for those stocks.

“You need to know your limitations. I don’t really know biotech.

“The only thing I can make a judgment on is the structure of the note.”

Ups and downs

Another reason justifying the need to be an expert in the sector was the extreme volatility of the fund.

With the pandemic, the amplitude of headline-driven price moves has intensified, he noted.

On Monday, for instance, Novavax rose 3% when the Food and Drug Administration announced its decision to grant the company its Fast Track Designation to accelerate access to the Covid-19 vaccine. The company expects to begin its phase 3 clinical trial in the United States and Mexico by the end of the month.

The S&P 500 index hit a new all-time high on Monday as Pfizer Inc. announced that a phase 3 of its Covid-19 vaccine trial developed with its German partner BioNTech SE showed a 90% effectiveness rate.

The share price of Pfizer climbed 8% and BioNTech’s price rose 14%.

No other example than Biogen Inc. can better illustrate the rapid cycling of biotech stocks. On Wednesday, the share price of the company jumped 42% after the FDA indicated its support for the biotech company’s experimental Alzheimer’s drug Aducanumab. On Monday, the stock crashed after the FDA voted against recommending approval.

Fund’s performance

Volatility can be seen at the fund level as well.

“This ETF has been all over the place. It can go to extreme opposite one year after the other,” he said.

In 2013, 2014 and 2017, the fund returned approximately 45%, according to Morningstar. Other years, such as 2016 and 2018, saw the price drop more than 15%.

The annualized performance over the past three years is 12.6%.

“That’s the problem. The annualized return doesn’t give you any indication of the volatility. When a fund can go up 50% and down 20%, I’m not sure a 30% cap on three-year is appropriate,” he said.

“You are taking a lot of risk. I don’t know if it’s reflected in the cap.”

The current race of a Covid-19 vaccine makes the future performance of the ETF all the more unpredictable, he noted.

“We have five companies working on the vaccine. You’re making a call on two or three companies in an index that has 150 stocks,” he said.

“Unless you’re an expert, you never know which stocks are going to be the big winners. You’re really gambling more than investing,” he said.

High risk, high reward

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, also found the underlying theme to be too specific as well as too volatile to warrant a cap.

“You really have to be familiar with biotech stocks,” he said.

“What we know is that it’s a high-risk, high-return sector.

“If you’re going to be chasing those kinds of returns, I don’t really see the point of having a cap.”

The 15% buffer was probably not sufficient, he added.

“These are high-risk, high-reward stocks. The buffer is not going to give you that much protection.

“If you want to take that bet, you have to be compensated for the risk.

“I don’t want to limit my upside to 10% a year for that type of risk. It makes no sense to me,” he said.

HSBC USA Inc. is the agent.

The notes will price on Nov. 19 and settle on Nov. 24.

The Cusip number is 40438CZK0.

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