HSBC’s five-year leveraged notes on Euro Stoxx 50 are appealing even for Euro skeptics

By Emma Trincal

New York, Dec. 3 – Even for advisers who have no choice but invest in Europe although they don’t like the asset class or would avoid the exposure altogether, HSBC USA Inc.’s 0% buffered uncapped market participation securities due Dec. 21, 2023 linked to the Euro Stoxx 50 index has enough to offer as a structure to overcome their discomfort.

The payout at maturity will be par plus at least 230% of any index gain, with the exact rate to be determined 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 lose 1% for every 1% decline beyond 25%.

Best choice

“This is a note that’s not particularly exciting but I might do it as an alternative to a long position in the index,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

This adviser tends to invest in shorter-dated products.

“I don’t really like five years. It’s particularly long.”

At the same time, international equity is part of any adviser’s core allocation. As such it makes sense to compare a direct exposure to the shares of a fund with a structured note.

“You may not like Europe – and I’m not that big on Europe, but you need international stocks in your portfolio and any non-U.S. equity benchmark is going to allocate at least 60% to Europe. In other words, if you’re an asset allocator, you can’t avoid Europe.

“If it’s a 25% allocation and I’m bearish, I may drop it to 15% or 10%. But I’m never going to zero.”

From that standpoint, the notes were a much better investment than an index fund, he added.

“Am I better off with 2x leverage, no cap and a 25% buffer? You bet I am.

“Even for the leverage alone I might do it,” he said.

Unloved benchmark

Michael Kalscheur, financial adviser at Castle Wealth Advisors, avoids investing in the Euro Stoxx 50 index, preferring by far the S&P 500 index for its geography and diversification.

“It’s only 50 stocks. You have a concentrated portfolio that’s Eurocentric. I’m much more comfortable with a broadly diversified U.S. equity index,” he said.

Kalscheur added that the “low-tech” exposure of the Euro Stoxx 50 index was a negative in his view.

“Betting against technology is like betting against the future. I don’t particularly want to bet against the future.”

The information technology sector represents 20% of the S&P 500 index and weighs less than 10% in the Euro Stoxx 50.

Powerful terms

Despite his disinclination to invest in the euro zone benchmark, Kalscheur said the structure of the notes won him over.

“Terms matter. A lot,” he said.

“If I had to get the exposure, would I buy the index fund or the note? I’d buy the note every day of the week and twice on Sunday.”

What about investing in notes linked to an index he would rather avoid in general?

“It’s a bad index. I wouldn’t buy the Euro Stoxx. But I might consider the notes because the terms are just unbelievably good,” he said.

Alpha

First, the leverage factor was high enough to easily make up for the loss of dividends, he noted.

The Euro Stoxx 50 yields 3.3%.

“You’re giving up a lot over five years. But the 2.3 times leverage is so high, you would break even with a 2.5% return per year. If the performance is below that, it would probably be the only scenario in which you would underperform the index. But 2.5% a year is an extremely low growth rate. It’s hard to do worse than that,” he said.

The uncapped upside increased the odds of outperforming the benchmark on the upside, he added.

On the downside, the buffer amount still exceeded the total dividends accumulated over the term.

“So here you are. You bought a mediocre index but the odds of doing well are significant.”

Back testing

Looking at back-testing data on the exchange-traded fund replicating the performance of the index, Kalscheur found that the chances of a decline of 25% or more over a five-year period were only 13.8%.

On the other hand, the index delivered an annual return in excess of the 2.5% break-even 40% of the time.

Kalscheur collected data on the SPDR Euro Stoxx 50 ETF since 2002.

“There’s a fair chance of outperforming on the upside even if this index continues to flounder for the next five years as it has over the past five or 10 years,” he said.

“And this huge buffer, especially on a five-year, limits the risk of losses significantly, making it very likely to beat the index on the downside too.

“Despite the fact that we don’t really like the Euro Stoxx and that we only get the growth rate of return as opposed to the total return, I think the terms make this note quite appealing.”

HSBC Securities (USA) Inc. is the underwriter.

The notes (Cusip: 40435UBT0) will price on Dec. 18.

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