HSBC’s 5% limited loss notes due 2020 on HSBC Vantage5 raise the bar on the upside

By Emma Trincal

New York, Sept. 19 – HSBC USA Inc.’s zero-coupon 5% limited loss notes due Sept. 28, 2020 linked to the HSBC Vantage5 Index (USD) Excess Return provide nearly full protection on a short-term tenor with uncapped upside leverage.

It’s just a matter of being comfortable with the underlying index and taking on the first small losses, sources said.

The payout at maturity will be par plus at least 121% of any index gain, with the exact participation rate to be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

If the index falls, the payout will be par plus the index return, subject to a minimum payment of $950 per $1,000 of notes.

Done on CDs

“I’ve been seeing a lot of leveraged deals on this particular index with full principal-protection,” said Jason Barsema, president and co-founder of Halo Investing, Inc.

This note protects up to 95% of principal but “forces” investors to lose the immediate small amount of index decline instead of having their investment cushioned against the first drop in a way akin to a stop loss.

“I’d rather get the full protection for a market already pretty likely to be down 5%,” he said.

“It’s just my personal preference. I don’t like taking the first 5% losses.”

This issuer has indeed priced a large volume of notes offerings and certificates of deposits linked to this Vantage5 index, according to Prospect News.

Momentum-based

Barsema said he was not sure he would be comfortable buying a note on this index without the full protection.

The HSBC Vantage5 Index (USD) Excess Return is a proprietary index of HSBC Bank plc. The algorithm provides a momentum strategy based on a basket of 13 exchange-traded funds across diverse asset classes including equities, bonds, real assets and cash. The synthetic portfolio is rebalanced monthly to achieve a volatility target of 5%, reducing as needed the risky asset proportion by allocating more to cash.

Other strategies

“With the 95% protection they’re able to give you 1.2x leverage. But I’d rather take the full principal protection with perhaps a little bit less leverage than taking the first 5% loss,” he said.

Barsema mentioned another option: introducing a buffer instead. But over such a short period of time the upside would probably be muted, he said.

“In theory, I would also like a deep, deep buffer, something like 40% or 50%. But buffers are expensive. I don’t know what kind of participation rate one may get but it may not work on a practical basis,” he said.

5% difference

The margin of risk between a 95% and full protection seems small. But it represents a world of difference in terms of pricing, a market participant said.

“Even with a low volatility index like this one, to pay for a protection all the way to 100 would be much more expensive than 95,” he said.

“It’s not a real principal protection. But it kind of is. You’re just getting your protection a little bit more cheaply.”

What’s in a name

The definition of what full protection is sometimes depends on what investors want or what their mandates allow them to purchase, especially for some institutional investors.

“We have several clients that have to buy principal-protected notes only. This type of 95% protected note would probably qualify for principal-protection even though it’s not.

“You have some additional upside with this structure,” he said referring to the upside leverage factor of the deal.

For conservative investors, the product can be a good compromise, he said.

HSBC Securities (USA) Inc. is the underwriter.

The notes (Cusip: 40435F2S5) will price on Sept. 25 and settle on Sept. 28.

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