HSBC’s dual directional PLUS linked to Euro Stoxx 50 offer alternative to direct exposure

By Emma Trincal

New York, May 2 – HSBC USA Inc.’s 0% dual directional trigger Performance Leveraged Upside Securities due June 5, 2019 linked to the Euro Stoxx 50 index offer a better alternative than a direct investment in the index if the market trades sideways, an adviser said.

However, the absolute return feature is not without risk, another one noted.

If the final index level is greater than the initial index level, the payout at maturity will be par of $10 plus 200% of the index return, subject to a maximum return that is expected to be at least 46.5% and will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

If the final index level is less than or equal to the initial index level but greater than or equal to the trigger level, the payout will be par plus the absolute value of the index return. The trigger level is 80% of the initial index level.

If the final index level is less than the trigger level, investors will be fully exposed to the decline from the initial index level.

Range

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, said that from a technical standpoint, the notes make sense given how the equivalent exchange-traded fund has traded so far.

Over the past seven years, the ETF has traded in a range.

“The share price is approximately 30% lower than its highest high. It’s also 20% higher than its lowest point back in 2012,” he said.

“As long as it’s not in the very low end of the range, you’ll be better off with this note versus a direct investment in the ETF. From that perspective it would be a better solution.”

Asset class

On a “fundamental” perspective, however, Chisholm said that he would stay away from European stocks.

“European countries have issues. There isn’t much growth out there. You could argue that it will continue to trend in the same pattern it has been in the past few years, which in theory could make the notes attractive.”

But Chisholm was just not interested in allocating to the region.

“I don’t invest in Europe. I don’t see it being a great driver of growth for the next three years. Europe has a lot of challenges,” he said.

“If you think Europe will continue to trade sideways, the notes are a great alternative to the index. But as an adviser, I’m just not investing in Europe.”

Fee, credit

Michael Kalscheur, financial adviser at Castle Wealth Advisors, also had some concerns about the underlying.

“It’s not my favorite index. Fifty stocks ... that’s very concentrated. When I invest in U.S. stocks, I pick the S&P 500, not the Dow Jones,” said Kalscheur.

The 3% fee is also a little bit high in his view.

“One percent a year ... that’s not a deal breaker, but it’s a little rich. It’s about as high as I would really like to go.”

Kalscheur said he was comfortable with HSBC’s credit, however.

“They’re not the highest rating, their spreads have widened, but everybody’s CDS spreads are wider than a few months ago. They’re still one of the tightest spreads.”

HSBC’s credit default swap spreads are at 92 basis points versus 114 bps for Barclays, 105 bps for Goldman Sachs, 102 bps for Morgan Stanley and 94 bps for Bank of America and Citigroup, according to Markit.

Return enhancement

On the positive side, Kalscheur said he liked the upside potential.

“The leverage is nice,” he said.

In addition, upside leverage is not the norm with these products as a majority of dual directional notes offer one-to-one on the upside up to a cap, he added.

“But more importantly the cap is substantial. It’s an excellent cap. I was very impressed.”

The notes offer a maximum annualized return of 13.6% on a compounded basis. Reaching the cap would require the index to increase by 7.2% a year.

Investors give up more dividend yield with the Euro Stoxx 50 than they would with a note linked to the S&P 500 index, he noted.

The Euro Stoxx 50 and the S&P 500 have dividend yields of 3.18% and 2.10%, respectively.

Lost decade

One problem for Kalscheur was the lackluster performance of the euro zone benchmark.

“This is an index that is basically unchanged. It has a really tough time compared to the S&P 500,” he said.

For the year, the Euro Stoxx 50 is down 0.15% versus a 1.83% gain in the S&P 500.

In the past 10 years, the Euro Stoxx 50 has only generated an annualized return of 10 bps, he said.

“Is it the lost decade for the European Union, or is it on its way to rebound? Who knows?

“Maybe Europe is Japan only 20 years behind. Maybe it will be stuck for another decade,” he said.

The outlook offers little to be excited about.

“It’s a higher yield, and you give it up. It’s a higher standard deviation, and you can lose your entire principal. The return of the index is basically zero. It’s pretty tough,” he said.

At the same time, some investors may find the upside potential appealing.

“That type of cap, especially combined with the two-times [leverage], can really boost your gains,” he said.

To assess the potential return outcome, Kalscheur looked at the ETF returns back to 1987. Over the 29-year history and during a three-year trailing period, the index finished at or below the 46.5% cap as much as 72% of the time.

“That’s a pretty good cap. You get capped out only 28% of the time. Not bad at all,” he said.

“That cap level is extremely good. The odds of outperforming the index are solid good given the cap and the leverage. With the leverage of two, the index doesn’t have to be up a lot, and you can easily make up for the loss of dividends.”

Risk

Unfortunately, the downside risk was too much for the types of investors Kalscheur caters to.

According to his statistics, there was over the last 30 years a 20% chance for the index to breach the 20% threshold on the downside over a three-year period. In comparison, the risk on the S&P 500 was only 7.2%.

For Kalscheur, the barrier, which he called “the cliff,” was not strong enough.

“The cliff is substantial. It’s a little scary,” he said.

“While I love the cap, the structure, the absolute, I can’t go to a client and say you have a 20% chance of losing money.

“This index is so volatile. I’d have to have a 40% cliff to feel comfortable putting my clients in the notes.”

HSBC Securities (USA) Inc. is the agent. Morgan Stanley Smith Barney LLC is handling distribution.

The notes will price May 31.

The Cusip number is 40434N143.

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