HSBC’s buffered uncapped market participation notes on S&P 500 offer defensive play

By Emma Trincal

New York, Sept. 18 – HSBC USA Inc.’s 0% buffered uncapped market participation securities due Sept. 28, 2023 linked to the S&P 500 index should appeal to cautious investors, but the absence of upside leverage will not be a good option for more bullish players, sources said.

The payout at maturity will be par plus any index gain.

Investors will receive par if the index falls by 22% or less and will lose 1% for every 1% decline beyond 22%, according to an FWP filing with the Securities and Exchange Commission.

Yield and tenor

Tom Balcom, founder of 1650 Wealth Management, said the note was attractively priced as a defensive play.

“This product was designed for cautious investors who worry about the market at elevated levels,” he said.

The long duration increases the cost of giving up dividends when comparing this product to a similar one on a shorter maturity, he said.

The S&P 500 index yields 1.70%, which would “cost” investors 8.5% over the five-year term, he said.

“However, the yield on the S&P is not as high as some other indices, in particular in Europe,” he said.

A five-year note on the Euro Stoxx 50 index would represent a much higher opportunity cost, he noted.

The euro zone index has a yield of 3.25%.

“You don’t have any leverage on the upside. But compared to high-yielding European indexes you’re not giving up as much in dividend, so in a way, the need for leverage is not as critical,” he said.

Lagging on the upside

Still, the absence of leverage was disadvantageous for the investor.

“Let’s round up the S&P yield to 2% and assume a 10% loss of dividend over the five years. You’re definitely going to underperform the total return of the index on the upside, no matter what, because there is no leverage,” he said.

“The index is up 50% in total return, you’re only getting 40%.

“You’ll underperform by 10% at all times on the upside.

“So while it has no cap, this is not really a bullish note.”

Solid buffer

The payout structure was more attractive on the downside.

“If the index is down, you’re not entitled to the 10% in dividend but you have a 22% buffer. So net, net you’re getting 12% in extra protection,” he said.

The notes were priced to allow investors to reduce risk when allocating funds to equity.

“The markets are at all-time highs. How do you convince someone to invest at those levels? New investors want to put new money to work, but they don’t really know how and where. This is a good conversation to have with a client. You get unlimited exposure to the upside with downside protection,” he explained.

“If you want to invest in equity, it’s a great way to put new money in the market at this late stage of the cycle.”

Prudent protection

Donald McCoy, financial advisers at Planners Financial Services, agreed.

“Because there is no leverage you will automatically underperform the S&P,” he said.

“The note is not designed for bulls. It’s a tradeoff in order to get the buffer.”

In normal times, getting that much protection over a long period of time may not represent the best use of money for investors, he said.

But uncertainty and high valuations in this late bull market warrant a sizable protection, he added.

“If you look at rolling five-year performance periods, the results tend to be positive. It’s not likely that you would get a 22% drop in that timeframe,” he said.

“But we’re at a fairly elevated state in terms of valuations.

“That doesn’t necessary mean we’re doomed.

“But the odds are higher now than they would have been five years ago.

“As P/Es are elevated, the likelihood of a negative five-year return increases.”

Risk mitigation

While worried about the risks of a pullback, investors also want to get exposure to the market.

“People have mixed feelings. On the one hand, they’re watching the news, they may get worried. Valuations are so high. They don’t know if they really want to put money in the market now,” he said.

“This is a way to get peace of mind. If the market is down 22% you’re back to even.”

McCoy also concluded that the notes can be used as a way to put money to work with some protection.

“This could be timely. If all of a sudden you are rebalancing your portfolio, or taking money from another place, it’s a good way to mitigate your risk.

“You get upside participation minus dividends with a good downside protection.”

HSBC Securities (USA) Inc. is the underwriter.

The notes (Cusip: 40435FZ91) will price on Sept. 25 and settle on Sept. 28.

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