HSBC’s $10 million phoenix with memory on S&P ETF seen as hard to allocate in portfolio

By Emma Trincal

New York, May 4 – HSBC USA Inc.’s $10 million of phoenix quarterly review notes with a memory coupon feature due May 2, 2024 linked to the SPDR S&P 500 ETF Trust could be seen as an equity substitute as well as a bond replacement, which gives allocators some room to decide where to allocate the security. But some of the terms of the product, including the tenor and the downside protection, make the allocation decision somewhat challenging, advisers said.

The notes will pay a contingent quarterly coupon at an annualized rate of 11.9% if the shares close at or above their 87% trigger level on the observation date for that quarter. Previously unpaid coupons, if any, will be automatically included whenever a coupon is paid.

The notes will be called at par plus the contingent coupon if the shares close at or above the initial level on any quarterly observation date.

The payout at maturity will be par plus the contingent coupon unless the shares finish below the 87% trigger level, in which case investors will lose 1.149425% for every 1% decline beyond 13%.

Range-bound

“Anyone buying this needs to have a range-bound view on the market for the next year,” said Steve Doucette, financial adviser at Proctor Financial.

The range was between 87% and 111.9%, an area where investors would outperform the fund’s performance.

“Problem is the market could go beyond that range in either direction,” he said.

Doucette was concerned about underperforming the ETF on the upside.

“12% is a decent return. But it’s a cap. Anytime I see a cap, I’m not comfortable with the risk of missing a huge rally.

“Call it fear of missing out.

“The Fed just raised rates. What happens if all of a sudden, they drop rates? The market would shoot to the moon.”

If the market was not so dependent on the Federal Reserve’s potential decision to cut rates, 12% would normally be a decent return for the equity portion of a portfolio, he explained. But it was not the case in today’s environment.

“The market can turn any time. We see how quickly it can turn,” he said.

“If I’m taking some equity off the table, I don’t want to cap myself.”

Not fixed-income

On the downside, Doucette said he liked the 13% buffer even with the downside leverage.

“I don’t mind geared buffers. That’s how you can get better terms,” he said.

“But you still have a considerable amount of risk. Who knows what’s going to happen in 12 months?”

In theory, the notes could be seen as a bond replacement.

From a risk-adjusted return however, Doucette excluded this option.

“A 12% yield is great. But it’s not the right risk profile. What if the market drops 30%? It’s a lot of risk for a fixed-income replacement,” he said.

Neither/Neither

In conclusion, the notes were difficult to allocate.

“I’m faced with a dilemma,” he said.

“If I put the note in equity, I have FOMO.”

The acronym “FOMO” stands for “Fear of Missing Out.”

“If I put it in fixed-income, I’m taking too much risk.

“It’s hard to position it in the portfolio.”

The “good thing” about the note was the memory feature, he said.

Doucette downplayed the risk of an early call in three months. But six months was a more likely outcome.

“If history repeats itself, the market should be down this summer. That’s been the pattern in the past. So, I think you probably won’t get called in three months. Six months out though, it could easily happen. You’re called in six months with a 6% return. Not bad.”

Too short

Matt Medeiros, president and chief executive of the Institute for Wealth Management, was concerned about the market risk over a short time horizon.

“I don’t like short-term notes. There may be a buffer but 13% is not enough downside protection,” he said.

In a pullback scenario, a one-year timeframe would leave very little room for a market rebound, he added.

“You definitely want a full business cycle ahead of you.

“I can understand that it’s hard to price the downside protection over a short-term period. That’s why I like longer tenors.”

The short maturity represented a challenge for the asset allocator.

“I don’t want to put a one-year note into my equity bucket. I hold my equity positions longer than that, typically for three to five years,” he said.

“A one-year is more speculative.”

Duration wildcard

Positioning the notes in the portfolio was made all the more complicated due to the unknown duration of the product by virtue of the call.

“Not only one-year is short, but what if I get called in three months? 3% in three months, or 1% a month, that’s a nice return. But how do you allocate something so short, especially when you don’t know how short it’s going to be?” he said.

Not knowing the duration of an already shorter-dated note made the risk management process more complex than it needed to be, he said.

Another possibility would be to treat the notes as an alternative investment. But even that option would not work, he said.

“I couldn’t even put it in my speculative bucket. It would not make enough money with a 12% cap.

“This note is very difficult to position in a portfolio. I can think of a number of places where I could put it but none of them would be a good fit,” he said.

HSBC Securities (USA) Inc. is the underwriter, and JPMorgan Chase Bank, NA and J.P. Morgan Securities LLC are the placement agents.

The notes settled on Tuesday.

The Cusip number is 40441X6A3.

The fee is 0.1%.

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