HSBC’s $388,000 autocalls offer worst-of index exposure, high double-digit premium

By Emma Trincal

New York, May 21 – HSBC USA Inc.’s $388,000 of 0% autocallable barrier notes with step-up premium due May 22, 2023 linked to the lesser performing of the Dow Jones industrial average, the S&P 500 index and the Nasdaq-100 index provide an unusually high coupon for an index-linked autocallable product. Investors need only be comfortable with an exposure consisting of the worst of three as opposed to two indexes.

The notes will be called at par plus a call premium if each index closes at or above its initial level on any semiannual observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The premium is 17% per year.

The payout will be par unless any index has finished below its 70% barrier level, in which case investors will lose 1% for each 1% decline of the least-performing index from its initial level.

“It’s not a coupon, but 17% is neat. You may get called in six months with 8.5%,” said Steve Doucette, financial adviser at Proctor Financial.

“I guess you’d have to think the market will continue to go up but slowly.”

Nice yield

Investors may not be overly bullish, otherwise the note could underperform the indexes, he said.

“But the coupon is already high. Will the market continue to go up 17% for another year? I doubt it,” he said.

“I kind of like this note. It’s a 17% if it’s up with a little contingent protection.”

If the notes are called in six months the annual return will stay the same.

If the notes are held longer, predicting the direction of the market could be difficult.

“You have so many bulls and bears out there. Recently Fidelity said that we’re in a secular bull market. Others come up with the opposite view...that we’re in a bear rally.

“I hear comparisons with the secular bull market of the 1980s, a very long bull market period...except that in the light of Covid, you don’t know.

“No one can predict what’s going to happen in the next three years,” he said.

Correlation

Usually stocks not indexes can generate this kind of high-double digit return, he said.

“I’m sure they boosted the coupon by adding a third index.”

“The interesting thing is that you’re dealing with three indices, but those three are highly correlated indices. It’s not like having the Russell or some kind of international equity fund in addition to the S&P and the Dow,” he said.

If the underliers were less correlated, the terms would be even better, he said.

“I like emerging markets. They’re undervalued. I wouldn’t mind replacing one of those indices with emerging markets. If you take the extra risk, you can get even more.

“I don’t know,” he said. “You might get a 20% coupon with a 60% barrier. You’d have to see.”

Equity substitute

Doucette does not always like the risk-adjusted return of autocallables: the upside is capped, and the principal is potentially 100% at risk if the barrier is breached.

In this case, his reasoning was different because he considered the notes as equity replacement not fixed-income substitute.

“We tend to use autocalls as bond replacement, something that’s going to give us a 5% to 10% coupon instead of 1% to 5%.

“This one, I look at it as an equity substitute.

“We wouldn’t try to use it as a fixed-income replacement. With a 17% return, that’s not what it is.

“We would swap an equity exposure for what appears to be a nice annual return with contingent protection.

“It’s a pretty good deal.”

Risk budget

Matt Medeiros, president and chief executive at the Institute for Wealth Management, said the notes would not be a good fit for his practice.

He typically does not buy worst-of notes. In this case, the presence of three rather than two underliers would be a drawback.

“You’re creating an additional level of complexity and you’re introducing challenges in the assessment of risk as you come up with more outcomes and therefore more probabilities,” he said.

“It would be hard to position this in the portfolio. The allocation process becomes more challenging.”

The correlation between the indexes helped. But it did not solve the problem risk allocators may face when having to decide how to weight and assess risk when positioning the notes in the portfolio.

“They’re all U.S. indices but with different constituents and different return characteristics,” he said.

“You don’t have probabilities on two indices but on three.

“The risk budgeting process becomes particularly challenging.

“You can’t really plan for an optimal allocation.”

Just because he would not use the note did not mean it was not suitable for another adviser.

“It’s a small size deal compared to the barrier of entry usually at around $1 million,” he said.

“It was probably designed for a specific investor or for a specific situation.

“I can see it as a bespoke deal.”

HSBC Securities (USA) Inc. is the agent.

The notes (Cusip: 40438CGE5) settled on Wednesday.

The fee is 0.5%.

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