HSBC’s buffered return enhanced notes on tech ETF offer narrow focus on technology sector

By Emma Trincal

New York, Oct. 1 – HSBC USA Inc.’s 0% buffered return enhanced notes due Oct. 28, 2022 linked to the Technology Select Sector SPDR fund give investors compelling terms. But the high valuation of the sector raises some concerns, advisers said.

If the final ETF return is positive, the payout at maturity will be par plus 2 times the gain, capped at par plus at least 30.6%, according to an FWP filing with the Securities and Exchange Commission.

The exact cap will be set at pricing.

If the final level of the ETF declines by up to 10%, the payout will be par. Investors will lose 1.1111% for each 1% decline beyond 10%.

The final level will be the average of the ETF closing prices of the five trading days preceding the maturity date.

Tech only

Steve Doucette, financial adviser at Proctor Financial, noted that the underlying fund narrowly focuses on information technology stocks, hence eliminating some of the high-flyers within the communications technology that heavily rely on technology.

“At least Apple, Microsoft are not through the roof like Amazon,” he said.

Apple Inc. and Microsoft Corp. together make for 44% of the fund’s portfolio.

NVDIA Corp., Adobe Inc., salesforce.com inc. and Intel Corp. are some of the other top holdings.

“It’s all tech without the FAANG stocks except Apple,” he said.

Strictly tech

The biggest driver of the recovery rally from March has been a group of stocks named FAANGs for “Facebook, Inc., Amazon.com, Inc., Apple, Netflix, Inc. and Google’s parent company, Alphabet Inc.”

Those stocks have skyrocketed in price. Amazon shares for instance have nearly doubled since their March low.

None of the FAANG stocks are included in the underlying fund because they are not technology stocks.

Facebook, Alphabet and Netflix are communication services providers. Amazon belongs to the consumer discretionary sector.

“It doesn’t mean the tech sector is cheap. But it’s a little bit less crazy than the FAANGs,” said Doucette.

The price-per-earnings ratio of the ETF is 22.

Amazon in comparison has a P/E of 121 and Netflix’s is 88.

Overlay strategy

“The 2x leverage with a 14% a year isn’t bad really,” he said.

On an annualized compounded basis, the least 30.6% maximum return represents a 14.3% cap.

“We’ll be past the Elections jitters. Maybe you can catch some upside at maturity, and it’s nice to have a 10% buffer,” he said.

Doucette said the notes could be used in conjunction with a long-only position in either the fund or some tech stocks.

“If you hold the stocks, you can capture a nice return and use the note as an overlay strategy,” he said.

“You get a little bit of leverage, a little bit of protection. The only downside is the cap if things go crazy.”

This adviser said he is relatively bullish over the two-year timeframe.

“We’ll be past the Elections...hopefully we’ll be past Covid too. The economy will return in 2021. You can pick up some upside return.

Asset allocation

“If you’re too bullish, you should be long the stocks and not worry about the cap.

“It’s a nice way to package your tech allocation because this is a sector that should be part of your asset allocation anyway.”

Doucette added that having a buffer and some leverage gave the notes the type of risk-adjusted return he seeks in a structured note.

“It’s a 10% buffer. You can beat the index on the downside. If we have a big sell-off and not enough time to get back up, you’ll be glad you have the leverage.

“You can outperform in either direction, which is what I’m usually looking for,” he said.

Growth ahead

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he liked the sector too, but the note was not defensive enough for his clients.

“I like the technology sector. It had a very strong run. However, I’m concerned about the headwinds in this market in the Post-Elections environment,” he said.

“Because of the rich valuations in tech stocks I think it’s a good idea to get the exposure to the sector through a structured note.

“But I would prefer a note with a deeper buffer.”

His solution to increase the protection would not consist of reducing the upside potential.

“I wouldn’t mind extending the maturity if this is what it takes to increase the size of the buffer,” he said.

“In fact, I might prefer a longer tenor. In two years, in theory you could be in the midst of a correction.

“I would extend the term and deepen the buffer. I could go five years for instance if I can get a 25% or 30% buffer.

“Tech stocks are going through an extended period of growth. But I’m not very bullish right now.”

JPMorgan Chase Bank, NA and J.P. Morgan Securities LLC are the placement agents.

The notes will price on Oct. 27 and settle on Oct. 30.

The Cusip number is 40438CXG1.

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