HSBC’s leveraged notes tied to Dow, Russell offer fair terms but timing, tenor eyed

By Emma Trincal

New York, Aug. 20 – HSBC USA Inc.’s 0% barrier enhanced participation notes due Aug. 30, 2024 linked to the lesser performing of the Dow Jones industrial average and the Russell 2000 index offer attractive upside potential and low barrier, advisers said. But the timing of the trade as well as the length of the investment was in question, according to an FWP filing with the Securities and Exchange Commission.

If each index finishes at or above its initial level, the payout at maturity will be par plus at least 130% of the gain of the worse performing index. The exact participation rate will be set at pricing.

Investors will receive par if each index falls by no more than 50% and will be fully exposed to any losses of the worse performing index if it finishes below the 50% barrier level.

Fine tenor

“The big risk is going to be in the next two years, especially for the Dow, which hasn’t dropped as much as the Russell so far,” a buysider said.

The Russell is down 14% from its all-time high of Aug. 31 last year. The Dow Jones industrial average on the other hand has only lost 5.2% from its recent record high of July 16.

At those levels, there is still “considerable downside risk,” he said, adding that the five-year maturity helps reduce the odds of a loss.

“Even if you see a huge 50% drop in the next two years, which in my view can certainly happen, there’s still enough time within the five-year period for the market to recover,” he said.

“That longer duration plays in your favor because a point-to-point decline of 50% is extremely unlikely.”

Entry point, volatility

It may be difficult to guess which of the Dow Jones industrial average and the Russell 2000 will end up being the worst-performing index, he said.

“The Russell is much more volatile. From top to bottom it could drop as much as 70% in the next bear market.

“But at the same time, the Russell has already been down for a year and it’s down far more than the Dow. “Also, volatility plays both ways. Once we recover from a recession, the Russell will rally a lot.

“So it’s hard to tell which one will be the worst index. It might be a tie,” he said.

On the plus side

Using the Russell 2000 and the Dow in a worst-of deal presented an advantage, he noted: their high level of correlation.

“It may be large-cap and small-cap but they’re both U.S. equity indices. They’re quite correlated, which will lower the risk somewhat,” he said.

The main elements of the structure were “fairly” attractive, he added.

“I like the five-year term. The market can rebound after a bear cycle.

“Having the 1.3 times leverage with no cap makes it very bullish.

“The only thing I don’t like is starting at those levels. On an inflation-adjusted basis, the Dow Jones Industrial has never been that high since the beginning of 2000.

“We are still very near the all-time highs. I don’t think the timing makes much sense,” he said.

Short-term attention span

Tom Balcom, founder of 1650 Wealth Management, also liked the structure of the notes. The longer tenor had value. But it represented a hard sale for clients who are hesitant to commit to the long-term especially at this late stage of a bull market.

“It’s a pretty large barrier and I like that. The chances to be down 50% five years from now are pretty small,” he said.

“It’s been 11 years since we’ve had a bear market. We’re due to have one. But who knows when and how severe it will be.

“The five-year term limits the risk of breaching at maturity because a bear market is not going to last five years.”

Yet the holding period would be an issue for this adviser’ clients.

“We don’t do more than three-years. People look at their quarterly statements. They focus on that.

“More and more people have access to information, news and trading platforms. Convincing clients to hold an investment for five years is difficult,” he said.

Good terms

But overall, the structure of the note was appealing.

“I like the no-cap. I like the 1.3 times leverage. The downside protection is very solid.

“It’s a decent note. Unfortunately, people are reluctant to put money to work for so long in this uncertain market. That’s the only thing,” he said.

HSBC Securities (USA) Inc. is the agent.

The notes (Cusip: 40435UUH5) will price on Aug. 27.

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