HSBC’s leveraged buffered notes linked to Euro Stoxx 50 designed for mildly bullish play

By Emma Trincal

New York, Nov. 13 – HSBC USA Inc.’s 0% market-linked securities with leveraged upside participation to a cap and fixed percentage buffered downside due Dec. 6, 2021 linked to the Euro Stoxx 50 index offer attractive terms, including leverage and protection, but the cap may not be enough for the more bullish investor, according to advisers.

The payout at maturity will be par plus 200% of any index gain, subject to a cap that is expected to be 60% to 65% and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 20% and will lose 1% for every 1% decline beyond 20%.

Carl Kunhardt, wealth adviser at Quest Capital Management, said he likes the notes for their risk-adjusted return.

“A cap of 13% a year is not too low. It’s a rational cap. It’s actually a very generous cap,” he said.

“There will always be people who think that 13% is not enough because European stocks are volatile and they can go up a lot compared to the U.S.

“But you have to take into account the risk-adjusted return. If you’re long the index you don’t have this 20% buffer.”

The 60% to 65% cap on the upside is the equivalent of a 12.5% to 13.35% compounded annualized return based on the tenor and leverage of the notes. In order for investors to achieve the maximum return, the Euro Stoxx 50 would have to rise by 6.8% to 7.3% per year.

Leverage provides value

While this performance does not seem like much, Kunhardt said the leverage could prove very helpful if the index turns out to be less volatile than expected and if the current rally decelerates, he said.

Investors have turned very bullish on European stocks on the view that they are more volatile than their U.S. counterparts and better-valued, offering more upside potential.

After lagging the S&P 500 index for several years, the Euro Stoxx 50 so far this year has outperformed the U.S. benchmark by four percentage points.

Kunhardt said he is bullish on Europe but not necessarily overly so, especially over four years. That’s partly due to the nature of the benchmark.

“Foreign stocks are volatile, but you’re not talking about China or emerging markets. You’re looking exclusively at Europe.

“Is Nestle that much more volatile than Hershey? Is Bentley that much more volatile than Cadillac? Europe is not as volatile as people think. The Euro Stoxx 50 is a blue-chip index. I don’t see it up 100% after four years.”

Kunhardt said that he always invests in the Euro Stoxx 50 as part of his international equity allocation, which “by default” is overwhelmingly comprised of European stocks.

“I’ve got to have it anyway. So the discussion becomes, should I hold it long or should I use a note like this one?

“The only thing I’m losing – and that’s a concern – is the dividends. But the two-times leverage overwhelms the downside of missing on the dividends.”

The Euro Stoxx 50 index yields 3.23%.

A ‘no-brainer’

Aside from the upside, Kunhardt said he is comfortable with the issuer’s credit and the “plain-vanilla” buffer, referring to the absence of any gearing on the downside.

“This note is a no-brainer to me,” he said.

Still, four years is a long maturity, he conceded.

“In general I tend to favor shorter-term notes because they allow you to redeploy the money quicker,” he noted.

But the holding period has to be assessed based on the offered terms.

“If you like the structure – and I certainly like this one – you don’t really care that it’s a four year,” he said.

“You always have this back-and-forth: is it too long? Can’t I use something shorter?

“But in this case, the terms are pretty good, so I can tolerate something longer. I don’t have to worry about reinvestment risk.

“As it is now, it’s a very nice note. In four years it may not be as great a note, but it’s not going to be a bad note.”

Not bullish enough

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, said he sees nothing wrong with the structure of the notes. But he simply does not agree with the implicit market view required to maximize the benefits of the product.

As the prospectus states, investors in the notes need to be only moderately bullish.

If the cap is 63%, investors will get 13% in annualized compounded return, which can be achieved if the index rises by 7.1% a year.

For Chisholm, both the cap after leverage and the real annual performance required to reach the top return are below his expectations.

“Thirteen percent a year is not bad, but this year the index did double that, and we could certainly have more years like that,” Chisholm said.

“It’s an interesting play, but I think in four years we could be much higher than the cap.”

The downside protection does not add much value, in his view.

“Buffers are good, but I’m less concerned about a buffer because I’m bullish. Four years is a long time, and if the index continues on the trend I expect it might, I think you’re selling a lot of the upside potential to buy a protection you’re probably not going to need.”

It is the mildly bullish view reflected in the structure that does not match his expectations.

“I’m less interested in that perspective. I look at the two times leverage capped at 60% over four years and based on what I expect to be the performance of the Euro Stoxx, I don’t think I need this.

“The cap is lower than my expected return.”

That said, the notes offer a sound structure for someone with an outlook other than his.

“It’s simple enough. In general, I like the risk/reward. I just think you can get more upside being long the index.

“But it’s a reasonable note for the right investor, and the construction of the note is fine.

“I’m just more bullish on the Euro Stoxx than what this note allows for.”

HSBC Securities (USA) Inc. is the agent.

The notes will price Nov. 30.

The Cusip number is 40435FKA4.

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