HSBC’s, Barclays’ 18-month notes with barriers fail to appease advisers’ bear market concerns

By Emma Trincal

New York, Nov. 19 – HSBC USA Inc. and Barclays Bank plc have priced and announced, respectively, 18-month notes with barriers linked to large-cap equity benchmarks.

While the notes have different underliers and payouts, their identical duration and similar barrier size enabled advisers to compare one to the other.

The first deal, which has yet to price, offers par when the index finishes above the barrier in negative territory.

The second, in a similar outcome, will give investors the index return between a digital payout and a cap.

Two deals

Barclays plans to price 0% notes due May 31, 2017 linked to the S&P 500 index, according to an FWP filing with the Securities and Exchange Commission.

If the final index level is greater than the initial index level, the payout at maturity will be par plus the index return. If the final index level is less than or equal to the initial index level but greater than or equal to the barrier level, the payout will be par. If the final index level is less than the barrier level, investors will share fully in the index’s decline.

The barrier level will be 82.95% of the initial index level.

Separately, HSBC priced $1.12 million of 0% digital dual directional notes due May 2017 linked to the Euro Stoxx 50 index, according to a 424B2 filing with the SEC.

If the index finishes at or above the 85% barrier level, the payout at maturity will be par plus the greater of the minimum upside return of 7% and the index return, subject to a maximum return of 25%.

If the index falls by more than 15%, investors will be fully exposed to the index’s decline.

Narrow window

Steve Doucette, financial adviser at Proctor Financial, said he does not like either of the notes because they use barriers to deliver protection rather than buffers.

“The Barclays looks like the only way to outperform is if you’re down,” he said.

“I would have a hard time buying the note thinking I’ll beat the market if I’m down. You outperform only on the downside and above 83%. It’s a very defined range, a very narrow window just to get par.

“Then you’re long the index. If a bear market comes in, you’ll burst through the barrier without any protection at all.

“You have room to go down to 17%. The average bear market is 20% down.”

Doucette conceded that compared to a long position in the index, the notes at least offer 17% worth of contingent protection.

“But here’s the hard thing. It’s an 18-month note. Within the next 18 months, it’s very hard to predict if we won’t be down by more than 17%,” he said.

“I guess the risk is too high for what you’re getting on the upside.”

Excess return

The HSBC note is slightly more attractive, he said.

“It’s a little bit of the same. You’re looking at similar parameters, but this note is a little bit better,” he said.

“First you have a more depressed index. The Euro Stoxx hasn’t quite ran as much as the S&P.

“Theoretically, if you buy cheaper you’re less likely to go down, so that’s a good thing.

“There’s a cap, but I’m not too concerned about the cap over 18 months.

“I don’t think anybody is going to complain about getting 25% over 18 months. That’s 16.7% annualized.”

The advantage of the structure, he noted, is that it gives investors a wider range within which the notes can beat the benchmark.

“You might outperform over a larger extent. If you’re down 15% and get the 7% minimum, that’s 22% in excess return, and you get that when the index is down. You actually get par like the other deal plus an additional 7% when you’re in that range. That’s not bad.”

Bear market ahead

Despite a more attractive reward scenario, Doucette expressed concerns about the market risk exposure.

“There again, the structure is a little bit weak on the downside,” he said.

“You have a 15% protection. The bear market sets in and you’re long the index.

“You still run the risk the market might pull back further than this.

“If you think the index is not going to drop 15% and that it’s going to be flat, if you expect that kind of range, that’s great.

“But if you hit that barrier, you’re long, and in a bear market, you can lose a lot.

“After seven years of a bull run we know a bear market is coming. Whether it’s coming in six months, 18 months or in two years, it’s coming.

“This is why I prefer the buffer. At least you get some outperformance while with a barrier you may or you may not.

“Since we know this 20% pullback is coming, the real question is whether this note adequately addresses that.”

Buffer wanted

Matt Medeiros, president and chief executive of the Institute for Wealth Management, reached similar conclusions, expressing unease with the barriers in both deals.

“The Barclays deal is pretty straightforward,” he said.

“But I’m more a fan of a buffer as opposed to a barrier.

“A barrier of 17% on an 18-month S&P note in the context of the S&P having a strong seven-year run so far makes me think that a pullback of 20% or more is certainly a possibility.

“Because it’s such a real possibility I would prefer a buffer with this type of underlying.”

He applied a similar reasoning to the other product, focusing on the risk of market-induced losses.

“With HSBC there is probably even more downside risk because there is more volatility in Europe right now,” he said.

“I’m interested long-term in both underlying asset classes, but my preference because of the environment would be more of a buffer than a barrier.

“In the last six to seven years both indices have been up.

“I wouldn’t mind making a longer-term decision if the condition to get the buffer was to extend the maturity.”

Barclays, J.P. Morgan Securities LLC and JPMorgan Chase Bank, NA are the agent for the Barclays deal.

The notes will price Nov. 20.

The Cusip number is 06741UU93.

The underwriter for the HSBC offering was HSBC Securities (USA) Inc.

The notes priced on Nov. 13.

The Cusip number is 40433UDE3.

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