HSBC’s $11.16 million leveraged notes on S&P 500 offer short-term bullish play

By Emma Trincal

New York, July 28 – HSBC USA Inc.’s $11.16 million of 0% leveraged buffered capped notes due Aug. 14, 2024 linked to the S&P 500 index provide all the elements of a well-designed, plain-vanilla note, advisers said.

But the fear of missing an uptrend or the concern about hedging losses led them to adopt two very different views about the risk-adjusted return of the investment.

If the index return is positive, the payout at maturity will be par plus 1.6 times the index gain, subject to a maximum settlement amount of $1,302.72 per $1,000 principal amount, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index declines by 17.5% or less and will lose 1.2121% for every 1% that it declines beyond 17.5%.

Steve Doucette, financial adviser at Proctor Financial, liked the structure. But he brought up one scenario, in which his main goal as a structured notes investor may not be achievable.

Beating the index

“I can’t argue with the buffer. If the market is down, you’ll outperform. It’s a decent size and I don’t mind the gearing,” he said.

“The leverage and the cap are both excellent.”

Assuming the payout hits the cap level, investors would still get a 14% compounded annual return, he added.

“It’s a neat cap. But it’s only neat when it ends up higher than the market at maturity.”

If the adviser buys notes to allow his clients to outperform regardless of the direction of the market, the cap may not be sufficient, he said.

“The only time you wouldn’t outperform is if the market was screaming back up. At the same time, who’s going to complain about a 14% return?” he said.

While all the elements of the structure – cap, leverage and buffer – made for a good note, Doucette said he would probably not add the security to his portfolio.

Underperforming the bull

“There’s one scenario, which could happen again, and that’s when the market comes screaming back up. We’ve been so spoiled with how quickly the market can turn. In 2020, the market went way down and came back in one month. I know it was a unique kind of bear market, a Covid-induced pullback,” he said.

“Now we just had an inflation pullback, and the market is up again.”

Doucette said it is hard to predict any market move over a two-year timeframe.

“But what if the S&P is up 40% and you’re capped at 30%? At least you have a nice-built up return. But still, you underperform the index. That’s something I want to avoid,” he said.

Doucette would seek “protection” against such “upside risk.”

“You don’t want to miss one of those huge rebounds,” he said.

Readjusting the cap

This adviser explained that his focus on the cap was aligned with his investment goal.

“It’s not so much the fear of missing out. The cap may be already high. But I don’t want to be limited by it and take the risk of underperforming the benchmark. My objective with structured notes is to outperform both ways,” he said.

“How likely is it that the market would be screaming back up in two years? I don’t know. But we know it can happen, and it can happen fast.”

Doucette would seek to eliminate the cap or at least raise it by giving up some leverage.

“You would still see a cap unless you go to three years. Maybe you need to allow more time to get a big increase in the cap or get rid of it altogether.

“All I know is that I don’t want to get capped out,” he said.

Fair equilibrium

Matt Medeiros, president and chief executive of the Institute for Wealth Management, expressed a more cautious view.

“This note is pricing at an interesting time where the S&P has been down 20% and now closer to 15% for the year. It’s at a relative fair value from a historic standpoint,” he said.

He first pointed to the features he liked.

“Because we have low return expectations, the leverage is attractive,” he said.

“I also like the relationship between the cap and the leverage. I think it’s a fair equilibrium. If you go with more leverage or/and a higher cap, you’re going to give up your buffer or other things.”

The use of a single index instead of a worst-of was also an advantage, he noted.

Term, gearing

On the negative side, however, Medeiros objected to the length of the note.

“I’m not a fan of short tenors in a note, and two years is quite short. It may not give you enough time to make up for losses if we go through another pullback. I prefer notes with a longer holding period,” he said.

Another drawback was the nature of the buffer.

“I just do not like geared buffers.”

The gearing allows to improve pricing and the additional losses it generates compared to a regular buffer may be modest as long as the index decline is not substantial, he conceded.

For instance, a 30% drop in the S&P 500 index would generate a 12.5% loss for holders of a note with a 17.5% straight buffer. The same note but with a 17.5% geared buffer would produce a 15.15% loss, which is only 2.65% more under the same market scenario.

“I think for geared buffers, everything depends on who is buying the note,” he said.

“If it’s an institutional buyer, it’s acceptable. They will understand the benefit of it.

“But if it’s for an individual investor’s account, you introduce some level of complexity that as a fiduciary, I’m not comfortable with. You may get some benefits from it, but overall, you’re still increasing your downside risk.”

HSBC Securities (USA) Inc. is the agent.

The notes will settle on Monday.

The fee is 0%.

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