HSBC’s trigger performance notes linked to Vanguard FTSE EM seen as attractive fund substitute

By Emma Trincal

New York, June 8 – HSBC USA Inc.’s 0% trigger performance securities due June 30, 2020 linked to the Vanguard FTSE Emerging Markets exchange-traded fund offer an attractive alternative to the benchmark for investors willing to commit funds for five years, financial advisers said.

The notes offer uncapped upside with a final barrier.

The payout at maturity will be par of $10 plus 124% to 134% of any fund gain. The exact participation rate will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

If the fund falls but finishes at or above the 75% trigger level, the payout will be par.

Otherwise, investors will be fully exposed to any losses.

Value

“I think it’s a good note,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

“When I look at a note, I want to get advantages versus just holding the position long because if I can hold the position long without the restrictions of a note, I’m going to do just that,” he said.

“In this case, the note gives me value beyond the cost.”

The notes carry a 3.5% fee, according to the prospectus. The fund’s net expense ratio is 15 basis points.

“This note is going to give me a smoother ride. The only two points that matter are when I bought it and when it matures,” continued Kunhardt.

“In five years the benchmark will increase potentially significantly.

“It gives me the leverage on the upside with no cap. It gives me some protection on the downside.

“It gives me more value than holding the positions long with the Vanguard fund.”

EM benchmark

Kunhardt said that investors should allocate a portion of their portfolios to emerging markets as part of their international equity bucket.

The Vanguard FTSE Emerging Markets index is one of the most recognized benchmarks for this asset class along with the MSCI Emerging Markets index, he noted.

Both indexes, often considered very similar, have some subtle differences, however.

The FTSE index does not include South Korea, a nation the index provider considers to be a developed country. As a result, big Korean multi-national companies such as Samsung are not part of the FTSE index.

The cost is another difference. The MSCI EM index carries a net expense ratio of 68 bps.

“The Vanguard fund has a big allocation to mainland China, but they don’t include Hong Kong,” he said.

“They also do add smaller company exposures. The FTSE emerging market stock index now includes 11.1% to smaller stocks.”

Buy and hold

The tenor of the notes is the only downside but one that could easily be overlooked, he added.

“A five-year hold is kind of long, but if I was going to use the Vanguard in my portfolio anyway I would use that as a substitute to the ETF,” he said.

Investing in a note versus a fund, which can be bought and sold daily, helps investors focus on a buy-and-hold strategy, he noted.

“With these notes I’m less likely to have a conversation with the client about the drastic up and down of the underlying index. They’re not seeing that kind of volatility on their statements. They’re just seeing the exchange price, not up 30% last month, down 40% this month,” he said.

Terms

Kirk Chisholm, wealth manager at Innovative Advisory Group, noted that the structure is a good fit for investors looking for exposure to the asset class even if the term is longer than he normally prefers.

“If you think emerging markets are a good place to be, this is a good substitute for investing in the space,” he said.

“You’re getting 1.3 times leverage, a protection down to 25% and unlimited upside.

“I think it’s a good trade even though five years is a long time, especially in this type of market where you have volatility around currencies, volatility around the bond market and volatility around stocks. It’s hard to lock yourself for five years in these kinds of notes with these kinds of volatilities in play.

“However, for somebody willing to hold the investment for that much time, it’s not a bad deal. There’s no cap; you have leverage and protection.”

Volatility

The underlying index consists of emerging market stocks, which tend to be more volatile than U.S.-listed equities due to a variety of factors such as political, market, economic, exchange rate, regulatory and liquidity risks, the prospectus warned.

Chisholm said volatility is a risk inherent to the asset class.

“The problem with emerging markets is that you get much more volatility than with developed markets. You get much bigger swings in the prices. If we have another global recession, they will be taking a hit by more than 25%. But that’s assuming that that happens,” he said.

“In the past six years, emerging markets have been up a bit, and now they’re flat. It’s hard to say what’s going to happen, especially five years from now.”

As of April, China represented the largest country in the index with 28.6% of the country allocation. It was followed by Taiwan (14.10%), India (10.8%) and South Africa (9.4%), according to the prospectus.

“India is certainly in a good position. China may not be in such a good position economically, but its market is growing. That’s because little by little, they’re opening up to the rest of the world. Most of the largest holdings are Chinese stocks in the FTSE index,” he said.

The index fund’s three largest equity securities were Tencent Holdings Ltd. (2.93%), China Mobile Ltd. (1.98%) and China Construction Bank Corp. (1.86%), all Chinese stocks, according to the prospectus.

“It’s a pretty reasonable note. And while I think five years is a long time, it certainly gives the investment theme time to play itself out,” he said.

HSBC Securities (USA) Inc. is the underwriter. UBS Financial Services Inc. is agent.

The notes will price June 25 and settle June 30.

The Cusip number is 40434E101.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.