Citi, HSBC to price notes linked to iShares MSCI EM ETF with same tenor but different outlook

By Emma Trincal

New York, May 1 - Two issuers each announced plans to price four-year notes linked to emerging markets with one product much more bullish than the other, sources said.

Citigroup Inc.'s planned 0% barrier securities due May 29, 2018 linked to the iShares MSCI Emerging Markets exchange-traded fund are not capped, but the payout will be 100% of any ETF gain, according to a 424B2 filing with the Securities and Exchange Commission.

In contrast, HSBC USA Inc.'s 0% trigger Performance Leveraged Upside Securities due June 4, 2018 linked to the iShares MSCI Emerging Markets ETF are designed for less bullish investors with two-times leverage and a cap of 55%, according to a 424B2 filing with the SEC.

Both structures offer contingent protection against losses through a final-day barrier. Once the barrier is breached, investors are fully exposed to losses from the initial price.

Citigroup will offer a barrier level comprised between 75% and 80%; HSBC plans an 85% barrier.

Four-year term

Steve Doucette, financial adviser at Proctor Financial, weighted the advantages of having no cap but no leverage versus having twice the ETF return but with a 55% cap.

On a compounded basis, the 55% maximum return is the equivalent of an 11.5% return per annum. The share price increase required to reach the cap would be 6.25% per year.

Doucette said that his hesitation between the two payouts was due to the four-year term, which is in part the price to pay to get some protection.

"Is the protection critical four years out? It doesn't seem that important for me," he said.

"I don't like the one-to-one because you're not going to outperform the index on the upside.

"With the other, you have a cap. But are you going to complain with an 11.5% annual return?"

Higher cap

The answer to that question depends partly on the underlying.

"I might try another index. If we continue on the bull market, the emerging markets is where you don't want to cap," he said.

"Instead, I would give up some leverage, like getting 1.25 or 1.5 times instead of two times, and I would raise the cap a little bit."

Not capping the emerging markets asset class too low is also a requirement in terms of asset allocation, in his view.

"Historically, the average performance of a diversified portfolio has been between 6% and 10%. If a portion of your diversified portfolio is going to raise the average, it would come from emerging markets. I wouldn't cap it," he said.

Buffer preferred

The notes are equally disappointing on the downside because they only provide for contingent protection, he added.

"I'd look more for the buffer rather than the barrier," he said.

"With the barrier concept, if your timing is wrong and the market is down, you're just long the index.

"It's the nature of the four-year duration that is problematic here. Suppose we're getting a bear market and the market recovers. At maturity, the bear market would have come and gone. In this scenario, I wouldn't need the protection anymore. Four years is so far out. The odds of this protection paying off could be very slim.

"If I have to be worried about the downside, I would rather have a buffer so I could outperform.

"There will be a correction. It's not a question of if. It's a matter of when.

"But I am interested in the emerging markets as an asset class. These economies are still growing faster than ours.

"You still need to rebalance, even though there is a risk."

Marc Gerstein, research consultant at Portfolio123, unequivocally said that he prefers the uncapped product.

"The HSBC is not as attractive as the Citigroup," he said.

"First of all, for the same maturity and the index, HSBC offers less downside protection.

"Sure you've got the leverage. That's an advantage. But they're giving you a modest return because of the cap, so it's a limited advantage."

Not bullish enough

For Gerstein, the uncapped product is a much better solution for bulls. He questioned why one would want to take the risk associated with emerging markets without being bullish.

"If you're not bullish enough to go with the non-capped deal, you're probably not bullish enough to go for emerging markets. Then buy the Russell 2000. Why taking on the risk overseas?" he said.

"If I wanted to go with this asset class, I'd want more upside than this cap. If you're that reserved about your bullishness on emerging markets, you shouldn't be in emerging markets anyway."

Gerstein said that he likes the asset class for its growth potential. In addition, the underlying ETF offers an attractive level of diversification between countries.

Adding puts

"It's pretty diversified. You have more flexibility to go where the action is. For people who want to invest in emerging markets, we have more flexibility now than 20 years ago," he said.

"I wouldn't mind having some exposure, not a core exposure but some, especially with the downside protection.

"The Citi deal offers 20% to 25% of potential protection, and you're getting your upside."

Even with that amount of contingent protection, investors may still be at a high risk of losing principal given the fund's volatility, he said. But the position could still be hedged.

"If I get a feel around the mid-term of the notes that I need more protection, I could always buy some puts. Four years is a long time with emerging markets, but I like this deal because it gives me a chance to make some good money.

"In comparison, the HSBC payout is too constrained. There may have been a better time for them to issue it when Citi was not also showing something similar, but in my view, better."

Citigroup Global Markets Inc. is the underwriter for the Citigroup deal.

The notes are expected to price on May 23.

The Cusip number is 1730T0Q36.

HSBC Securities (USA) Inc. is the agent of the HSBC offering with Morgan Stanley Wealth Management as dealer.

The notes will price May 30 and settle June 4.

The Cusip number is 40434C592.

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