HSBC’s digital dual directional notes linked to S&P 500 show protection, return enhancement

By Emma Trincal

New York, Jan. 14 – HSBC USA Inc.’s 0% digital dual directional barrier notes due Jan. 29, 2021 linked to the S&P 500 index offer absolute return through a digital payment, which may enhance the upside compared to more typical structures of the same type, advisers noted.

If the index return is greater than or equal to negative 20%, the payout at maturity will be par plus the greater of the index return and the minimum upside return, which is expected to be 23% to 28% and will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

If the index return is less than negative 20%, investors will have full exposure to the index’s decline from its initial level.

Return enhancement

Steve Doucette, financial advisor at Proctor Financial, noticed the difference between this digital version of the absolute return structure and the most common one.

“The absolute return is leveraged somehow because you’ll get at least 23% when you’re above the barrier,” he said.

“In a typical dual directional note, investors get 100%, sometimes 50% of the decline in absolute return, not a fixed payout.

“You would get plus 10% for a 10% loss or 1% for a 1% decline. Here, they give you 28% for a 1% decline. That’s a form of return enhancement.”

Another advantage is the unlimited upside.

“The market could go down and back up, but at least this one is not capped. You have the index, so you have the upside potential.

“As long as you don’t hit the barrier, you know that you’ll get at least 28%, which is 5.6% per year. If the index doesn’t do much over the next five years, you’re going to outperform.

“This note might be appealing for folks looking to replace fixed income.

“A guaranteed 5.6% is pretty good in that case, especially if the market is down within the range.”

Five years

Doucette, however, said he would probably want to enhance the upside given the long duration.

“It’s the five years out that’s the hard part for me. It’s too hard to predict,” he said.

“The 20% protection is good. Hopefully it won’t be a factor.

“I would be curious to see what terms I could get on the upside if I was willing to bring down the absolute return. You could still have a huge outperformance potential.

“I’d like to capture a little bit more return, get less absolute return. I could even get rid of the minimum return so I can get leverage on the upside.

“That to me would solve the issue I have with this note: what happens if the index is up more than the minimum return? You’re just long the market and you’ve held the notes for five years.”

Attractive protection

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said the protection is attractive in the current environment.

“I like the idea of having a protection on the S&P. I like the idea of having protection in this market, period, especially when you have a long-term view,” he said.

“The S&P as a core holding generally represents a long-term view.

“The general expectation at least for the next five years is more in line with historical averages. It might be an advantageous time to look at these notes because of the recent pullback in the S&P. We may see additional pullback, maybe even a correction.

“But over the next five years, I don’t see a correction that would impact the barrier of this note.

“In other words, I don’t see the probability of being 20% below the purchase price at maturity.

“But should that happen, it’s obviously good to have that protection.”

While the minimum return is “relatively small,” it would generate a significant excess return if the market were “slightly down” at the end of the term.

“Even a loss smaller than 20% I think is unlikely. But again, if it happens, the absolute return would make you outperform the market a lot,” he said.

“It is a long-term note, but if the purchaser is comfortable with the credit risk of the issuer, it seems to me the note is in line with how we’re thinking about the market.

“There are times when you want to take the brakes off and other times when you want to be more prudent in the way you pursue opportunities. I think we’re more in this second scenario.

“It’s time to focus on risk a little bit more. Uncertainty and volatility are up. More protection is good to have.”

HSBC Securities (USA) Inc. is the underwriter.

The notes will price Jan. 26.

The Cusip number is 40433UFN1.

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