HSBC’s AMPS linked to Euro Stoxx 50 offset lack of dividends with ‘decent’ terms, adviser says

By Emma Trincal

New York, June 19 – HSBC USA Inc.’s 0% buffered Accelerated Market Participation Securities due June 23, 2020 linked to the Euro Stoxx 50 index offer terms that are attractive enough to offset the disadvantage of foregoing high dividends, sources said.

If the index return is positive, the payout at maturity will be par plus double the index return, subject to a maximum return of at least 47%, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 15% and will lose 1% for every 1% decline beyond 15%.

Yield

“For someone who wants generic European exposure, this is something worth taking a look at,” said Michael Kalscheur, financial adviser at Castle Wealth Advisors.

“You’re giving up a pretty fat dividend ... almost 3% a year. ... But that’s the price you pay for having the downside protection. That’s part of the deal.

“Overall you get pretty decent terms in exchange.”

The Euro Stoxx 50 yields 2.9%, or one percentage point more than the S&P 500 index.

While the 15% buffer does not eliminate downside risk, it mitigates the chance of losing a significant amount of principal, he added.

Backtesting

Kalscheur said he uses historical data on indexes to assess the probabilities of losses and gains on a given index.

Based on statistics on the Euro Stoxx 50 going back to 1987, he found that the euro zone benchmark dropped beyond the 15% buffer level 25% of the time.

Noting the risk, which he attributed to the concentration of an index made of only 50 stocks, he said that the buffer is nevertheless “rock solid” for a three-year term.

“If the market is way down, I have the buffer. I’m going to outperform.”

It is all the more necessary to have downside protection given the medium term of the notes.

“A lot of people anticipate a major crisis in the next three, six or 12 months. I think a lot of those fears are overblown. But nobody knows” what the next three years are going to be, he said.

Cap

The notes offer the advantage of striking a balance between potential gains and risk mitigation.

“The more downside protection you have, the more you’re going to have to give up something. It’s usually the cap,” he said.

“When you get a 7% a year cap, I usually move on to something else, like an aggressive bond allocation. If you’re going to take equity risk, you have to get equity-like return. This note offers a very good cap at 47%. It’s almost 14% a year.”

The cap is 13.7% on an annualized and compounded basis.

Alpha potential

The leverage allows investors to maximize the return at a relatively low level.

“You cap out if the index is up 7% a year. That’s very reasonable,” he said.

“I like that you can outperform and not be overly optimistic. You can have low expectations.”

There is an “upside risk,” however, based on his statistics. Those suggest that 24.7% of the time, investors would have been “capped out,” as the index would have generated returns in excess of the 47% limit.

“You’re not winning all the time. But you have a good chance to outperform,” he said.

“The only way you lose compared to the index is if the market is widely bullish or goes nowhere.

“The issuer did a nice job putting together a product that gives you the best chances to beat the index.

“It’s a very compelling offering.”

Growth play

Scott Cramer, President of Cramer & Rauchegger, Inc., said that for growth investors, not getting the dividend could be an acceptable concession to make given the double upside exposure and the one-to-one downside.

The 15% buffer is also a factor that helps offset the loss of dividends.

But more importantly, the view is determinant in the decision to use the notes or not.

“For people who are growth-oriented, you’re not going for this for the dividend ... you simply need to be a believer in the growth story,” Cramer said.

He made the case for investing in European stocks from a value perspective.

“I think valuations for the S&P 500 are stretched, and while they’re stretched on the Euro Stoxx too, they’re not as stretched. There is a little room for growth with Europe,” he said.

Cramer liked the three-year tenor from that standpoint.

The leverage is also an attractive aspect of the product.

“You’re getting leverage on the upside but no leverage on the downside, which is worth remarking.”

The European markets are not without risk, he noted.

“I do believe there is more political risk in Europe than in the past. There is more event risk too like terrorist attacks. These are going to be the outliers for a market disruption event.”

But Cramer said that the notes could still make sense for investors looking for growth in an asset class that offers more value than U.S. equity.

HSBC Securities (USA) Inc. is the agent.

The notes were scheduled to price on Tuesday and settle on Friday.

The Cusip number is 40433U7M2.

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