HSBC’s trigger PLUS on KraneShares CSI China Internet ETF show rarely used underlier

By Emma Trincal

New York, Feb. 14 – HSBC USA Inc.’s 0% trigger Performance Leveraged Upside Securities due Feb. 17, 2023 linked to the KraneShares CSI China Internet ETF bring to investors a new name as the underlying, but the fund’s volatility and current price level make the product slightly risky, said Steven Jon Kaplan, founder and portfolio manager of TrueContrarian Investments.

If the final share price is greater than or equal to the initial share price, the payout at maturity will be par of $10 plus 200% of the ETF return, subject to a maximum return of 43%, according to a 424B2 filing with the Securities and Exchange Commission.

If the final share price is less than the initial share price but greater than or equal to the trigger price, the payout will be par. The trigger price is 80% of the initial share price.

If the final share price is less than the trigger price, investors will be exposed to the decline from the initial share price.

Second time

“This fund has been around since 2013, long enough to get a good idea. China during that time had a series of bear and bull markets,” said Kaplan.

“It’s good to see something a little bit different as opposed to the usual S&P 500 index.”

Data compiled by Prospect News showed that it is only the second time the KraneShares CSI China Internet ETF has been used in a structured note.

Prospect News tracks notes that are registered with the SEC.

The first issue – Credit Suisse AG, London Branch’s $3 million digital barrier note due June 1, 2022 – priced in May 2019.

Price action

The coronavirus outbreak in China added some volatility into the play, Kaplan noted.

But based on historical prices, this fund hardly needs a negative headline to move a lot.

For instance, in January 2018, the ETF hit an all-time high at $66.05 a share. By the end of that year, it was down to $36.00, a decline in excess of 45%.

On Jan. 13 of this year, when the news came out about the new virus in China, the share price was at $54.77. By Jan. 27, it dropped more than 15% to $46.40.

“It’s a pretty big drop for that short period of time,” he said.

But the stock has rallied since then despite the coronavirus, which continues to unnerve investors. On Friday, the fund closed at $52.23, a 12.6% gain since its low at the end of last month.

“The share price has recovered most of the loss. It’s almost as high as Jan. 13, which was not the all-time high but the most recent high, so it’s close to some sort of recovery high,” he said.

If the market’s angst around China where the virus originated may have helped push down the share price at the end of last month, it is not the first or the last factor to drive the volatility of this ETF, he said.

Coronavirus in perspective

“The media keep trying to adjust the story to fit the price moves,” he said.

“But we saw how the stock lost nearly half of its value in the second half of 2018.

“Moreover, the virus has zero impact on the actual earnings of those companies.

“Eventually though, the media have an impact on prices because people keep on overreacting to the media headlines.”

The market cycles should be seen as the real drivers of price action over long periods of time, he noted.

“This ETF plummeted in 2018 because emerging markets were very unpopular,” he said.

“There was hardly any change with the internet companies.

“It was a broader trend. Emerging markets were in bear territory in 2018 following a massive bull market the previous year. Because the percentage increase was so high in 2017, the market was reverting back.

“The market has its own logic. The media can encourage people to buy or to sell when they don’t have reasons to buy or sell.”

Not at fair value

Kaplan has reasons to buy a security when he sees good value. Such is not the case with the underlying of the notes. As a result, he would not invest in the notes.

“I’m not personally bullish. The Chinese market is fairly valued,” he said.

“Internet shares are overvalued around the world.

“People get emotional about these tech companies as opposed to boring stocks like banks or manufacturing.

“It’s a magnet for day traders chasing after returns.

“That’s why these stocks can move a lot.”

Three-year term

Another reason not to consider the notes was the tenor.

“The three-year is not ideal. It is likely to be close to a world-wide bear market if we have a repeat of the kinds of bear markets that followed long bull markets.”

The current bull market is the longest in U.S. history. Kaplan expects the next bear market to last longer than the 15- to 18-month average. He also anticipates prices to drop significantly more.

China’s situation is different, he said. But if the U.S. enters a bear market, China will follow.

“Unlike the U.S., China has already had bear markets in the past few years. They could behave differently but up to a point,” he said.

If Chinese stocks were undervalued, the deal would be more appealing. But it is not the case anymore.

“Chinese stocks are cheaper than U.S. stocks. But they’re not a bargain. They’re a little bit on the high side right now,” he said.

Thin barrier

The combination of a volatile underlying, relatively high valuations and the risk of a global bear market make noteholders exposed to potentially sizable losses, he added.

“There’s a significant risk of getting knocked out. The Chinese market, many times, has been going down by more than 20%.

“As we saw in 2018, this particular ETF can drop quite a lot.

“It also dropped 40% in 2015.

“Historically, it’s been down more than 20% quite a few times.

“That’s not a good thing if you buy the notes. It’s just a very volatile ETF. It’s much more volatile than the Nasdaq.”

Wait or protect

If he had to invest in the fund via a structured note, Kaplan would wait for the next pullback.

“It’s worth buying the fund or the notes when the price is low,” he said.

“In the beginning of 2019, when the fund was at 36, it was probably worth taking the risk then so you could get a better chance of capturing a decent return.

“If I wanted to make the note more attractive, I would have a real buffer rather than a barrier, especially since a 20% barrier doesn’t do much.

“I do like the fact that it’s based on a totally different type of fund. Maybe a year from now it would be more attractive. But right now, it’s too soon.”

HSBC Securities (USA) Inc. is the agent. Distribution is through Morgan Stanley Wealth Management.

The notes will settle on Feb. 20.

The Cusip number is 40438G300.

© 2015 Prospect News.
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